128: Modular Financial Planning 06: Eliminate High-Interest Debt

[00:00:00] Intro: Do you think money takes up more life space than it should? On this show, we discuss with and share stories from artists, authors, entrepreneurs, and advisors about how they mindfully minimize the time and energies. Spent thinking about money. Join your host, Jonathan DeYoe, and learn how to put money in its place and get more out of life.

[00:00:33] Jonathan DeYoe: Hey there and welcome back to Mindful Money. We’re in the middle of reviewing the 10 episode, , mindful Money Modular Financial Planning Process. Last time we talked about emergency funds, and if you don’t have one, I recommend going back and listening to that episode before listening to this one. I. An emergency fund is your first line of defense that keeps a small setback like an illness or a job loss from becoming a major financial disaster.

[00:00:58] Today we’re gonna take the next [00:01:00] step and talk about eliminating any and all high interest debt. This episode is the sixth in our 10 part series, which covers everything you need to know about creating, starting to create your own. Do it yourself. Modular financial plan. Now, as I said at the outset of this series, a financial plan is meant to guide you towards your ideal future.

[00:01:20] But it is important to recognize that this path isn’t always a straight line. Your financial road, like the rest of your life is multi-dimensional. It’s not just a matter of how far you have to travel. Also where we start sometimes frankly, we fall down on such occasions. The path must traverse the many switchbacks of a steep and relentless climb.

[00:01:41] In financial terms, the difficulty of the climb is usually about debt, and overabundance of debt makes your journey harder and riskier. Too much debt, especially the wrong kind of debt, can make the climb seem impossible. Because debt is so common and can cause so much pain. Getting [00:02:00] out of debt is the top financial priority for many people.

[00:02:03] Too much debt makes it hard to keep that vision of your perfect life in focus. Debt becomes deeply emotional and creates many challenges such as guilt and shame, and it can derail any small progress that we make. It can destroy a savings habit and it can drain your emergency fund if you let it. So I can’t overstate the importance of eliminating high interest debt.

[00:02:27] However, I also can’t overstate the importance of being kind to yourself. If you are in debt, you’re not alone. It may or may not even be your fault. Forgive yourself and just take the first step to get out of debt.

[00:02:40] So what counts as high interest debt? Every credit card, payday loan, or buy now, pay later loan is likely high interest.

[00:02:49] , these typically carry 10 to 30% interest charges, which is more than you can reasonably expect to ever earn investing. So if you expect your investment portfolio to earn [00:03:00] six or seven or 8% return over the long term, but you’re carrying debt with an interest rate of 10% or more, you’re losing financial ground the longer you have that debt.

[00:03:09] And it’s not just credit card loans that qualify as high interest. Any after tax interest rate that is higher than the long-term average return you expect in your investments is working against you. So there are many consequences of debt. , one thing that’s gonna help motivate you to get started is an awareness of what’s at stake.

[00:03:27] As great as it feels to grow wealth for the future, it feels equally bad or worse if you understand how our brains work and our basic negativity bias to burden yourself with debt. A large amount of consumer debt relative to your income casts a Paul over your entire life. Heavy debt results in poor credit scores, which can pollute every aspect of your finances from buying a car to renting an apartment, even applying for a job.

[00:03:55] Debt can also impact you physiologically. It is a major [00:04:00] stressor that can increase your chances of heart disease, sleep disturbance, and digestive conditions among many, many, many other health issues. Not to be overlooked are the social effects. As debt produces a tremendous amount of shame, which may lead to self-defeating and self-destructive behaviors the opposite.

[00:04:18] Freedom from debt is good for your finances and it will also improve your health and happiness.

[00:04:23] So if you have high interest debt, how much of your resources should you put towards paying that debt off? There is no one size fits all plan for attacking high interest debt. The urgency of your need to eradicate debt increases with the size of the debt and the interest rate you’re paying.

[00:04:40] Fair warning, though, it’s possible to go overboard with debt reduction, a common pitfall to avoid is paying down debt so aggressively that you sacrifice your emergency cash reserves. Without emergency reserves, you’re gonna be in double trouble if a crisis strikes. That’s why paying off debt comes after building your emergency fund in the Mindful Money Modular Financial Planning [00:05:00] process.

[00:05:01] Once your emergency fund is in place, apply any excess money from your budget to your high interest debt, so to help speed the process along, you may be able to refinance your debt at a lower interest rate. That’s if you have decent credit or you may negotiate your debt directly with vendors. In some cases, utilizing a low interest balance transfer from a, credit card, those offers you get in the mail, , that’s a sometimes an option provided you don’t use that extra breathing room to take on more debt or increase your spending.

[00:05:30] And in the worst cases you can look into declaring bankruptcy. Now I’m not a bankruptcy attorney and I know, . The rules have changed, making it more difficult and sometimes more damaging to declare bankruptcy. But if you’re overwhelmed by high interest debt, it may be your best bet. So please consult with a debt management specialist to find your best path forward.

[00:05:49] So let’s talk about the steps for eliminating high interest debt probably goes without saying, the first and foremost step to getting rid of debt is to quit adding more [00:06:00] debt. Do what you can to reduce or stop using your credit cards. You can, , quit tapping your credit and convert yourself to an all cash economy.

[00:06:07] I’ve heard stories of people putting their credit cards literally in the freezer. Whatever works for you is worth pursuing. Again, if you have an overwhelming amount of high interest debt relative to your income, consider seeking. Professional help, such as credit counseling or debt relief programs, or join Debtors Anonymous if you’d be comfortable, , with sort of an accountability partner.

[00:06:29] Explore all your options. There’s always something you can do to climb out of debt.

[00:06:33] So there are. Two standard approaches to debt retirement. There’s the debt snowball and the debt avalanche. If you have more than one account with high interest debt, some financial advisors favor paying off the smallest balances first, then moving up to higher balances as you apply, , additional freed income.

[00:06:52] The benefit of this approach known as the debt snowball is that totally knocking out one debt at a time provides a nice psychological [00:07:00] boost as you’re likely to eliminate the first accounts quicker, and you may feel motivated to keep going. Personally, It’s tougher, but I prefer the more financially sound approach, which is the debt avalanche.

[00:07:10] Here you throw as much money as possible at the debt with the highest interest rate first, while continuing to pay the minimum balance due on all other accounts, plus a hundred percent of any charges and monthly interest accrued. Then you move on down the debts with lower , interest rates. Generally, with this method, you’ll save more money on interest payments and retire your debt faster.

[00:07:30] One of the discussions I get into is whether it’s better to pay off debt or invest additional funds if you have them right up front. I’m a huge fan of investing and starting that lifetime compounding engine. Both eliminating debt and investing for your future are a key to living a happy financial life.

[00:07:47] But if you’re carrying debt at 10% interest or higher, it’s wise to pay off that particular debt first before investing, , because that kind of debt. The compounding is working against you at the [00:08:00] same time. It’s crucial. You start the compounding engine, the earnings on your invested earnings as soon as possible, because time is literally of the essence for compounding.

[00:08:08] Compounding returns are the primary driver of long-term financial freedom at higher interest rates over 10%. You wanna focus on paying down the debt first, and if you can move all your debts to lower interest rates, say between five and 10%, then you wanna start investing even if it means living with some debt.

[00:08:25] There are certainly exceptions. The big one is the 401k match. If you have access to a 401k and your employer has a matching program, you want to capture the full match. If they match their first 4% contribution, then you’re gonna want to contribute 4% to your 401k to capture the full match. That’s a hundred percent immediate return on your investment.

[00:08:44] If they only match 50% of your contribution up to 6%, then you’re gonna want to contribute the full 6%, which means you’re getting a 50% immediate return on that investment. you’ll have to find the right balance for you, but if your employer is offering free money, you want to take [00:09:00] it well, you can’t ignore your high interest debt.

[00:09:02] You don’t wanna postpone building wealth either. If you have debt with rates in the five to 10% range, then you may want to consider a 50 50 split commit. Half of any excess money to paying off this moderately expensive debt before investing the remainder in your future. Ultimately, the larger your debts and higher interest rates, the more important it is to pay them off quickly.

[00:09:23] In such cases, investing may have to wait.

[00:09:26] Today more than ever, I’m getting the question from people about paying down their low interest debt, and we’ll recommend that, but not at this stage. Most of these questions are coming from people who have older mortgages on their homes. I’m talking three plus years old with interest rates below 3%.

[00:09:44] That they’re considering prepaying, I definitely would not be prepaying these loans. My mortgage rate’s 1.75%, , and it’s locked in for 10 more years. I will never prepay that for the simple reason that inflation is [00:10:00] higher than my interest rate, which means that I’m actually paying my regular mortgage payments with lower value dollars every year.

[00:10:07] It sounds weird to say, but inflation is helping me pay off my mortgage

[00:10:11] now. I’ll always have to make the minimum payment, but why would I ever take money out of a portfolio producing, you know, between six and 8% long term to pay off a loan? That only costs me 1.75%. If I did, I’d be hurting myself.

[00:10:25] So don’t be afraid of all debt, whereas high interest debt puts you behind low interest.

[00:10:31] Debt can reverse the equation. When interest rates on your debt are lower than 5%. You may make more money in the long run if you use your surplus cash for investing rather than for paying off this cheaper debt. Not only do home mortgages carry low interest rates, especially the older ones, meaning the return you see on your investments will likely be higher than the cost of your mortgage.

[00:10:51] They often have tax advantages as well.

[00:10:54] So with any debt, it’s worth noting that debt is inversely proportional to happiness. More [00:11:00] debt equals less happiness. The greater the amount of debt you conquer, the happier you’ll become.

[00:11:05] Once you deal with your debt, you free up saving capacity for more fruitful uses. So I hope you can start, to see how these modular planning steps become dominoes. Once you have a vision of your perfect life to pull you through the hard times, you start your savings habit required to, sort of realize that vision.

[00:11:24] , the first place you save is your emergency fund, and then you start to pay off your high interest debt. As always, thanks for listening. I hope our audience members find this process helpful. Next time we’re gonna move on to the most important and universal savings goal, retirement. Thanks again for listening.

[00:11:42] Outro: Thanks for listening. Full show notes for each episode, which includes a summary, key takeaways, quotes, and any resources mentioned are available at Mindful Money. Be sure to follow and subscribe wherever you listen to your favorite [00:12:00] podcast. And if you’re enjoying the content and getting value from these episodes, please leave us a rating and review ratethispodcast.com/mindfulmoney. We’ll be sure to read those out on future episodes.