Episode Transcript
Brenton: [00:00:00] When you have a lot of debt and you can't pay it off all at once, it can be helpful to have some tools to optimize what you're currently dealing with. In this episode, we're gonna give you five key ways you can recharacterize the structure of your debts to benefit you financially.
Let's get started.
Brenton: Hello, my name is Brenton Harrison of New Money, New Problems, and your host for the New Money, New Problems podcast. I hope you guys enjoyed last week's [00:01:00] episode where I promised you that after the break we were gonna talk about five ways that we could optimize your debts instead of just paying them off in full.
And as I shared in that episode, we went a little long in the tooth, so we decided to split this up into two parts, so, whereas last week we kind of talked about the ways where you can change your debts and figure out which ones to pay off in full, this episode is more so about how to manage the debts that you're gonna have for a while in the best way possible.
So we're gonna share five ways, and this is by no means an exhaustive list, but just five actionable ways that you can restructure your debts to make sure that you're getting some good benefits. We're gonna start first with mortgages, and I will tell you we're gonna do some episodes later on in this podcast where we talk about the potential benefits of deciding to pay off a mortgage faster and aggressively. So people who are making twice their mortgage payment or three times their mortgage payment, trying to make a 30 year loan be paid off in 10 years or a 15 year loan be [00:02:00] paid off in seven. In this instance, we're not talking about someone who has either chosen to pay it off that quickly, or they may just not have the ability to pay it off that quickly. So the two areas within this section that we're gonna talk about are adjustable rate mortgages, and then also more conventional, 15 or 30 year mortgages.
With an adjustable rate mortgage, essentially what you have is a limited period of time where you have a fixed rate on your mortgage. It might be a three year ARM, a five year ARM, a seven year ARM, and after that period of time, your mortgage can increase by a certain rate that has a cap on it every single year.
So you could have that loan for 30 years, but it's only the first three or five or seven where the rate is fixed. And after that fixed period, you are literally beholden to whatever market rates are at that time. And I'm telling you, there are a tremendous amount of people out there right now who are staring down the end of the fixed period on an adjustable rate mortgage that they probably secured during the period where interest rates were starting to creep [00:03:00] up.
So they were looking and they were saying, let's, instead of getting a fixed 30 year loan, bank on the fact that these rates are gonna decrease, so maybe we get a five year ARM or a seven year ARM, and in that period of time, they're hoping that rates will go back down.
Well, if you are somebody who got like a three year ARM or a five year ARM, now you're looking and seeing oh, there's a real possibility that not only will rates not go down, but they'll be significantly higher than where they even are now.
So what do you do?
Well, unfortunately, when it comes to an ARM, there's not much financial benefit to paying extra on the mortgage itself. It's not like by putting an extra 500 or a thousand dollars a month on an ARM, that you're somehow better positioned at the end of that fixed rate period to get an improved interest rate. That's not how things work. Interest rates for home loans are based on your credit, but they're also based in many cases on how much you can buy down your rate.
Buying down your rate is essentially paying increased closing costs to reduce the rate of your mortgage. [00:04:00] As an example, they may say, if you will pay an extra point, which is an extra percent of the loan amount towards your closing cost, we'll decrease your mortgage by 0.25% or 0.5%. And over the course of 10, 20, 30 years, even a quarter of a percent difference can mean tens of thousands of dollars that you could save, but it also on the front end, saves you on your mortgage payment. So if you have an ARM, rather than paying extra towards the ARM, if you're trying to position yourself for the best rate possible after that fixed rate period expires, you might be better suited to save as much money as possible in a side account.
A high yield savings account, a money market account, so that when that fixed period ends and you likely would refinance to a fixed rate conventional 15 or 30 year loan, you have as much in that side account as possible to buy down your interest rate as far as you can.
But if you already have a fixed rate loan that's more conventional for 15, 20, or 30 years, [00:05:00] even if you have a really low interest rate loan, there's still some optimization that can be done without you making a great amount of change to the current structure of your finances.
And what I'm referencing in this case is switching what's likely a monthly payment to a biweekly payment. When you pay once a month, there are 12 increments of the year in which you're making payments. January, February, March, so on and so forth. Biweekly payments does not just say, oh, instead of paying once a month, we're paying twice a month.
It's saying we're paying every other week, and there are 52 weeks in a year. Biweekly means you are paying 26 times, and that means you are essentially making an extra payment towards your mortgage each year. Now if you're thinking about that making one extra mortgage payment, couldn't you just make an extra mortgage payment at some point during the year?
You absolutely can. A biweekly mortgage payment is something that just takes advantage of the tools we talked about in previous episodes, like automation.
And when you look at that biweekly payment, it can lead to substantial [00:06:00] savings over the course of a 15, 20, or 30 year mortgage.
As an example, if you're following along with us on screen, we have a household that has a mortgage balance of $300,000 for a 30 year mortgage at 7%, and we're gonna compare what they would pay over the course of that 30 years with monthly payments as opposed to biweekly payments. With monthly payments their mortgage for principal and interest is just under 2000. It's $1,995 a month. Over the course of 30 years, they would pay $418,000 worth of interest on that loan. Not in totality, just the interest. Conversely, if they switched to biweekly payments every two weeks, their payment will be $997. They would pay 311,000 in interest, so that's over a hundred thousand dollars less in interest over the course of 30 years. And because you are making payments more frequently and more and more is going towards the principal , switching to biweekly actually leads them to pay their mortgage [00:07:00] off significantly faster. As a matter of fact, if you're looking at an amortization table on this example, you can see that they pay a 30 year loan off in 23 years. So they save seven years and shave that off of the Repayment period as opposed to monthly payments on a 30 year note.
The next section where we can talk about savings is with student loans, and this has a lot to do with how much you owe on student loans relative to your income. You can find a different number or a different percentage depending on which, consultant or advisor that you talk to. For me, I just say my line in the sand is if you owe more in student loans than you are earning each year, then you are likely a candidate for federal student loans to pay them back using an Income Driven Repayment plan.
We've talked about those a lot to this point on this podcast and also on our unaffiliated podcast, Escape Student. loan debt not connected to New Money, New Problems, but Income Driven Repayment plans. As we've shared, our plans were instead of paying based off of what's needed to pay the debt off in [00:08:00] full, you choose to pay a percentage of a number called your Discretionary Income each year.
And one of the ways that you can lower your Discretionary Income is by lowering your Adjusted Gross Income.
And you can decrease your Adjusted Gross Income by doing some other behaviors that actually benefit you financially. Things like contributing to a pre-tax retirement account like a 4 0 1 K or an IRA, putting money into plans like health savings accounts or flex spending accounts or dependent care flex spending accounts like you find in your employee benefits package. And if you can find a way to contribute to those types of accounts while also having an Income Driven Repayment plan, you are lowering your Adjusted, Gross Income and lowering your loan payment.
So that's one way to save with federal student debt. But what if you have a lower amount? What if you owe less than one times your income, or even if you have private student loans? Well, in this scenario, one of the ways that you can restructure your debts in a way that benefits you is to consider refinancing with a private lender.
If you owe less than a hundred [00:09:00] percent or 150% of your income in federal student loans, or if you have a private student loan, then it's highly likely that instead of having your loans forgiven, you're gonna end up having to pay off your loans in full. And if you have to pay your loans off in full, you want to do so at the lowest interest rate possible because it will lead to interest rate savings over the course of time.
So these candidates are perfect for looking into refinancing their debt with a private lender. One of the benefits of refinancing with a private lender is that with private student loans, you can refinance as many times as you want to without adding anything to the balance of the debt. And this is very rare when you refinance things like a home loan, they're often closing costs or origination fees that are prohibitive. If it costs you 10 or $20,000 every single time you refinance a house, you're not gonna just do it willy-nilly. You're gonna wanna make sure that there's a ton of savings on the back end of that refinance. With private student loans, there are no origination fees in most cases, which means that even if you refinance your loans 30 different times, you [00:10:00] still owe the exact same as you did on the proceeding loan. But the second reason that refinancing with a private lender, or at least researching it is helpful is because also, unlike most forms of debt, many private student loan lenders will give you a peak at what the interest rates are that you might receive by doing a soft pull of your credit. And that soft pull gives them enough information to quote you an interest rate that you might receive if you fully apply.
But because it's a soft pull, it does not dinging your credit score. So you can get your score checked or your interest rate checked with a dozen different private lenders to see if you could potentially save and if it turns out that there is an opportunity to have significant savings and you decide to formally apply, Only at that time would they do a hard pull of your credit that does impact your score.
These reasons are why for people who have private student loans or could potentially benefit from them, I often encourage them to check rates at least once a quarter because even if they refinance multiple times in a [00:11:00] single year, it could potentially benefit their student loans.
[00:12:00]
Brenton: The last area before I let you go this week is a big one and it is credit cards. And there are two main ways that you can optimize your credit card debts.
And those ways are mostly based off of the credit score that you bring to the table before you optimize. So we're gonna start with people who have high credit card debt, but also high credit scores as well.
If you have a high credit score, it's likely that you're eligible for what's called balance transfer cards. Balance transfer cards are credit cards that are offered to you with an introductory period where if you take debt from another card and transfer it to the new offering, you can pay it at 0% for 21 months or 18 months, 15 months, what have you. And if you have services like Credit KARMa, which is actually what we're looking at on screen, or Experian, There are even marketplaces that will look at your credit score and they will present you offers for [00:13:00] balance transfers for which you have a high odds of approval based on your particular credit score.
So what people will do is they will systematically transfer funds to the 0% card, pay it down at 0% interest, and lower the total cost of paying off credit card debt from somewhere likely in the twenties at this point in time, down to 0%, which can also save you not only time, but a significant amount of interest expense.
The problem however, is that not everybody has a high enough credit score to qualify for these balance transfer cards, and by high I would say you need to have in the low seven hundreds to be even eligible for most balanced transfer offers. So it's not something that even all high income earners can take advantage of, especially if you're struggling to get rid of the credit card debt that you already have.
So there is a second way that you can optimize your credit card debt, and that is through utilizing a personal loan. A personal loan is something where you can go to a lender and you can say, Hey, I have $20,000 worth of credit card debt. I want to borrow $20,000 from [00:14:00] you as a personal loan to pay off, said $20,000 on the credit card.
And if you're wondering, well that's just the same thing. You're robbing Peter to pay Paul. You still owe $20,000. There are some benefits to the structure of a personal loan as compared to credit cards. The first is with most personal loans, the interest rate on these debts is lower than what you'll find with your typical credit card.
So the first benefit is you lower the total cost of debt. The second benefit is you have a defined period of time in which you're gonna pay off that personal loan.
But the last benefit is something that's not very widely known, and that is the structure of a personal loan compared to a credit card. With a credit card, you can borrow it over and over and over again, and that type of debt is called revolving debt. And these types of revolving debt are the only types of debt that are reflected in credit utilization.
And credit utilization is the second highest factor contributing to your F I C O score. It is 30% of your F I C O score. So if you have a [00:15:00] credit limit of 10,000 or $20,000 and you currently have. 60, 70% of that limit on your cards, your credit utilization is probably trashed.
And in turn, your F I C O score is nowhere near as high as it could be. Personal loans conversely are installment debt. You borrow it once and that's the only time you can borrow it. So because you have taken it from revolving debt to installment debt, even though you still owe the same amount, you have erased that debt from your revolving credit, which means you've erased it from your credit utilization as well.
And this is why in many scenarios when people use this strategy, they can see an improvement in their credit score almost overnight because of that immediate transfer in the way that debt is viewed for your credit.
These are just some of the myriad different ways that you can optimize the debts that you have in your portfolio that you can't pay off in a year or two. I hope this was useful. We have more tips that we're gonna share over the coming weeks, and eventually we're going to do a standalone, a series of episodes on credit[00:16:00] for things like what we just discussed.
But I hope to see you all next week ready for another New Money,, New Problems episode. See you then.
