Episode Transcript
Brenton: [00:00:00] When you have multiple debts, trying to figure out which one to pay off is a difficult thing to do. So in this episode, we're gonna go through some scenarios that give you an idea of how to prioritize your debts and establish a plan for Repayment. 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 am back from vacation. I hope you all enjoyed last week's [00:01:00] departure from our usual episodes, but I am back. And this week I wanted to talk about something that I've had come up more frequently as student Loan payments are about to resume as interest rates increase and people's budgets get pinched a little more than they have been in the years past. And that's the prioritization of debts.
And if you don't have any Debt, this may be an episode that you skipped, but for the majority of people out there, you have this kind of mix and hodgepodge of debts, whether it be credit card, Debt, little student, Loan a car, Loan a mortgage, and you can get through periods where you're trying to either get budget relief or.
Or you're just trying to be responsible and get as close to no Debt as possible. And you're trying to figure out if I have a couple extra dollars here or there, which Debt should I address first? Or what is the prioritization in terms of how I attack these items to get said relief?
So what I wanted to do is give you an idea of some of the things that I use when working with clients to help them get a clear [00:02:00] perspective on which Debt should take priority when they're trying to pay things off.
So what we'll be doing in the first half of the episode is giving you some of those considerations and even giving you some scenarios where I would say if this, then that. And then in the second half of the episode, instead of paying extra on a Debt, we're gonna give you some ways that you can shift the structure of a Debt, without having to pay it off in full and still get some of that relief.
One of the first considerations I go through when talking with clients who have multiple forms of Debt is the interest rate conversation, and this is a two-part conversation. The first part of that conversation is, is it a high interest rate or a low interest rate. With all things being equal. If you had two $10,000 loans, Obviously a Loan that has a 20% interest rate, would have a little bit more priority than that $10,000 Loan that had a 10% or a 5% interest rate. That would be the one, all things equal that would take priority, but part B [00:03:00] of the interest rate conversation takes into consideration the future trajectory of those interest rates, and I'll tell you how that can differ. Let's say that I have one type of Debt that is a fixed interest rate. That could be something like a car Loan, where maybe I owed $10,000 on a car, Loan at 7% interest. Well, if all things were being equal and I had $10,000 at 5% interest, I would likely put that Loan at a lower priority.
There's a higher interest Debt out there to be repaid. But maybe that $10,000 that I owe at 5% is the current interest rate for a type of Debt whose interest rate is variable. That could be something like a variable student Loan with a private lender. It could be a line of credit. I. It could be a home equity line of credit, a securities back line of credit.
In that scenario, you have to add in the consideration of the future trajectory. Things like what's going on with the Fed, as we've talked about a few weeks ago. In a rising interest rate environment, variable debts are one of the [00:04:00] first areas where you see an increase. So in this scenario, it's $10,000 at 7% fixed.
$10,000 at 5% variable. I may instead choose to put extra funds towards the variable Debt to take into consideration the fact that in the future that interest rate could eclipse the fixed 7% interest.
And when you think about all those things and you talk about variable interest rates to me, One of the types of Debt that I hate the most, which I don't know how frequently I've said it over the years, but I think that credit card Debt is just the bane of many high income earners existence. And there are several reasons why we are actually more keen and more likely to accumulate credit card Debt while still having high credit scores, than a lower credit borrower who is limited with how much Debt they can accrue on a card because they just have lower limits on those cards, period. For a high income earner, you could have access to tens of thousands of dollars on an individual card, and it makes you more likely to accrue that Debt.
Well, that is the perfect [00:05:00] storm of a variable interest rate debt at a high interest rate as well. So when I prioritize debts and I see people who have credit card Debt of high amounts, I laser in on questions like, what is your credit score? What percentage of your total credit limit are you borrowing?
But there are some other options to recharacterize the structure of that Debt, which may be the relief you need that doesn't require you to have that be the first one that you throw extra dollars towards.
The next two considerations are somewhat of a couplet as well. Part A of that couplet would be the required minimum payment for those debts. I often encourage people when they're going a step beyond the interest rate conversation and trying to figure out where they get the most bang for their buck. To think about how quickly they could pay off a Debt and combine that with the budgetary relief they would get from paying off the Debt.
And sometimes those can make the priority shift a little bit. As it pertains to required minimum payment. I wanna make sure that if I'm [00:06:00] throwing, I. Extra dollars to something. It is something where once it's paid off, it gives me a significant amount of budgetary relief. I'm not gonna be throwing $10,000 a month, it's an extreme scenario over a $50 a month bill, because if I have other debts as well, those dollars may be better equipped to give me more budget relief by paying those first instead.
So part A of the couplet is the required minimum payment. All things being equal, I want to pay off a Debt, for example, that has a $300 monthly payment before I pay off a Debt that has a $200 monthly payment. But part B of that couplet is what is the remaining balance on those loans? If I happen to have a Debt that has a higher monthly payment as compared to my other debts, but I am years away from paying it off where those other debts may have a lower monthly payment, but I'm a year or maybe less to paying it off, I might choose to put those elements together and decide to throw extra money at something that has a significant minimum payment, although it may not be the [00:07:00] highest minimum payment, but I'm closer to paying off. I'll give you an example. Let's say that I have a Debt where I have $5,000 remaining on that Debt, and the monthly payment towards it is $200 a month.
Conversely, I could have a Debt that's a higher required minimum payment at $300 a month, but there's $20,000 remaining as compared to five. Even though that first Debt has a hundred dollars lower monthly payment, I'm only $5,000 away from paying it off. I'm much closer to my goal, and once I reach that goal, I have $200 back in my budget, much faster than if I put that towards the $20,000 trying to eliminate $300, but I won't be eliminating it until maybe two, three or four years down the line. This is how you pair those two items to determine for this element, which should take priority.
[00:08:00] [00:09:00]
Brenton: The next consideration is any introductory or limited time offers. You see this very frequently when you might have a credit card, for example, that has a 12 or 15 month introductory rate on new purchases of $0. Or a balance transfer where there's a limited time where you can pull funds over for $0.
You see this with adjustable rate mortgages. All of these things are gonna be items that we talk about in more detail in future episodes. But with an adjustable rate mortgage, you have a limited period of time, three, five, or seven years where the rate on your mortgage is fixed, and after that period of time, it could increase to match current market rates.
In those scenarios, especially in a rising interest rate environment, those can, unless there's another way to restructure the Debt, like with a credit card, those can be things that take higher priority. If I have only 12 months where I have 0% interest, all things being equal, I may want to take advantage of the fact that even though it's a lower interest rate than other debts, Every single dollar I make and [00:10:00] pay is going towards the principle.
And if I pay down that principle within that period of time, I'm taking advantage of that limited time opportunity. As it pertains to adjustable rate mortgages, it's not something in most cases that I would say to pay down faster. It's something to consider restructuring, and that's something we'll talk about after the break as well.
Next? Are there any terms or is there any possibility of forgiveness? This really pertains in most cases to federal student loans.
We've talked on this podcast and on our Escape Student Loan podcast, which is not affiliated with New Money, New Problems, about Income Driven Repayment plans and public service Loan forgiveness program. Whereas a part of those programs, you can have your loans forgiven after 10 or 20 or 25 years.
If you're doing calculations and you are determining that under an Income Driven Repayment plan or under public service Loan forgiveness, it makes more sense for you to aim to have your student loans forgiven than it does to actually pay them off in full, then that now becomes a Debt where you shouldn't pay an extra [00:11:00] penny towards the Debt.
And If you're aiming for forgiveness, you want to pay the least amount possible towards the Debt and have the maximum amount forgiven as possible.
And then lastly, what is the impact on your credit score? I cannot wait till we get into the series on credit because I feel like there's a lot of things I have to share that could be beneficial to you. But here's what I'll say for the sake of this episode: the second biggest element of your credit score, and in my opinion, the only element of your score that can be greatly impacted in a short period of time is your credit utilization.
Credit utilization is a representation of the percentage of your available credit that you have borrowed at a particular point in time. Now the thing about that is credit utilization only measures the percentage of your available limit on revolving Debt, which is essentially Debt that you can borrow over and over again.
That would be something like a credit card. If you have a $10,000 limit on a credit card, you can borrow that $10,000 as many [00:12:00] times as you want to, as long as you keep paying it back. The other type of Debt is installment Debt. That's something where you borrow it once and it's done.
That's a mortgage. That's a car loan. That's a personal Loan that you might take out from a bank. Thankfully, personal loans are not reflected in credit utilization. So if I'm looking at two debts, all things being equal and one of them does not impact my credit utilization and the other does, if I'm someone who thinks I'm going to need that credit in a short period of time, I'm going to focus on the things that impact my credit utilization. The majority of that is going to be something like a credit card. And in some cases, even debts that are revolving, they do not impact credit utilization in the way that you would think. As an example, a home equity line of credit is something that does not show up in most credit utilization scenarios.
So even though both of those are revolving forms of Debt, There are reasons why a home equity line of credit does not show up and a credit card payment does. So when you're comparing these things and you think you might need [00:13:00] credit in the near future, the last element is to consider that one of these elements could impact your credit score and the other could not.
I'll give you one example of how I might use these scenarios to figure out which Debt to prioritize. Let's say that I have a credit card at $10,000 of a balance, which is a decent sized balance. It's a 20% interest rate, and it's $250 a month as the minimum payment.
Now, what boxes does this check? It's a decent sized payment. It's a decent sized balance and it's a variable rate that does impact, and in fact, greatly impacts my credit score. Let's next assume that we have a car Loan that's $5,000. It's half of what I owe on the credit cards. It's a 8% fixed interest rate and it's a $450 monthly payment.
Now the fact of the matter is it's a significantly lower interest rate. But it does have a high monthly payment at $450 a month. Lastly, let's assume that we have a home equity line of credit that [00:14:00] we owe $20,000 on. So it's our biggest Debt by a sizable amount. It's a 10% interest rate, which is a variable interest rate that is decently high. It's $166 a month that we're paying on the payment. Now if I'm prioritizing this, even though I owe the most amount on the variable rate home equity line of credit, that would probably be my last priority for several reasons.
The first is home equity line of credits, the payments on them are much more forgiving in many cases than what you would find with the interest rate and payment with the credit card. The second thing is, even though the interest rate is variable, it does not impact my credit. And the last thing is the payment is only $166 a month.
So I'm the furthest away from paying this Debt off and it's causing the least amount of damage to my monthly expenses, and as a result, I would likely pay this off last.
So now it's a battle for second and first place. Well, for me, and this is gonna be different for each person, I'm just giving you tools that you can use to [00:15:00] assess for me. I would likely put the credit card as the second highest priority instead of the highest priority. Now I know that interest rate is higher than any of the ones we've discussed, and it's a variable interest rate as well. I also know that this impacts my credit the most of all of these types of Debt because it impacts my credit utilization.
I also know that it has a significant monthly payment at $250 a month. But I owe double on this card what I owe on the $5,000 car Loan. And even though the car loan's interest rate is lower, the payment is higher at $450 a month. So in my mind, if I pay as much as I can to get that $5,000 gone, I can pay it off more quickly than my other forms of Debt and I can free up $450 a month in my budget to attack priority number two.
So this is the type of conversation I'm talking about where you're looking at all of the things that impact your decisions and some [00:16:00] mixture of those elements can cause you to prioritize a Debt that you wouldn't think would be the highest priority, but in the long run, makes the most sense financially.
Now y'all know that I take this very seriously.
I put my agendas together, my outlines when we're doing these episodes, and I try to make sure that I cover things in a particular period of time. But you also know that I don't know how long that's gonna take until I get into the episode. So this entire time I've been referencing the fact that we're gonna do some things after the break.
Those things being telling you some ways that you can restructure those other debts. Instead, we're gonna make that a part two. Try to keep these episodes to 15 minutes or less, if possible. Definitely less than 20 minutes, uh, whenever possible if it's not an interview. So we're gonna push that to part two next week. And in the interim, we're gonna put out a spreadsheet that shows you some of these categories that you can use to prioritize debts.
I also want to encourage you all to sign up for our email list, and if you have 15 or 20 minutes to consider filling out our New Money, New Problems gap finder.
You hear about that in the [00:17:00] commercials for this podcast. But it's 15 to 20 minutes that takes you through some of the gaps that you have in your finances and some areas where you might want to give a little more attention. One of those areas in the gap finder is about your Debt,
so it gives you an idea of some touch points that you might want to consider on your journey, and this is the perfect time to encourage you to go and check out that gap finder and see what it tells you, and come back next week armed to get some more information that will help you as you pay these things off.
See you next week.
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