Dealing with Debt

I recently published a quick FI primer.  I heard from several readers it was nice to have an easy intro into FI concepts.  My whole purpose is to help educators find the path to FI. So, I plan to publish a simple concepts post every Thursday for the foreseeable future.  This is my first.

(Note:  If you have no debt or feel comfortable with the basic concepts of dealing with debt, skip this post.  I value your time!)

Debt

Nothing will kill your FI dreams faster than debt.  To achieve financial independence, you need to have savings.   Savings are much harder to create when you have debt drawing off money in interest.  Savings are impossible to create if you are borrowing to fund your spending.

Easy mode:  Avoid debt

Unfortunately, debt is a reality for most of us when starting the path to FI.  If we haven’t avoided it, then we need to eliminate it. We’ll explore the basics of debt elimination in this post.  We’ll also talk about special advantages teachers have in eliminating a common form of educator debt: student loans.  I’ll also share how we approached eliminating our debt.

First, Know Your Debt

To deal with debt, you need a game plan.   To develop a plan, you need to know what you’re up against.  Start by creating a simple list with the following categories:

• Debt type
• Company that holds the debt
• Amount
• Interest rate

This information is easier than ever to obtain since most debt is now managed online. Log in and look it up.  If you can’t do that, you can look at your most recent statements or call the company which owns the debt.

Here’s an example of what this might look like:

Yours may look different.  You may have more entries, higher amounts, worse interest rates.  Don’t get discouraged. Knowing your debt is empowering. Now you know what you’re going to eliminate!

In general, most of us have three types of debt:

• Consumer 
• Mortgage
• Student Loans

Consumer debt is the worst because it indicates bad spending habits and has the highest interest rates.  In particular, credit cards pull you farther and farther into debt. We’ll talk about two methods for attacking your consumer debt in a bit.

Mortgage debt is the subject of another post.  Typically, it’s larger, has a lower interest rate, and may be included differently in your FI plan.  It’s almost always preferable to eliminate other debt before mortgage debt.

We are going to start with student loans.  Why? Because educators have advantages in dealing with student loan debt!

There are three student federal loan forgiveness programs that educators can use to reduce or eliminate their debt.  Here is a brief overview of each, and links where you can learn more.

Warning:  Some types of loan consolidation can prevent you from using these methods.  Some consolidation can be advantageous, but pay attention to the details.

Perkins Loan Cancellation

That’s right, total cancellation!  This program will forgive up to 100% of your Perkins Loans if you teach in a low-income school or teach in certain subjects or eligible specialties.

Full forgiveness takes five years and is applied at the following rates:

• 15% in your first and second year
• 20% in your third and fourth year
• 30% in your fifth year.

My wife, Teacher FI, met the eligibility criteria. But, consolidation of her Perkins loans through a private lender rendered her ineligible.

For more information on Perkins Cancellation visit Studentaid.gov here.

Teacher Loan Forgiveness

If you teach full time for five consecutive years in a low-income school or education service agency, you are eligible for up to $17,500 in loan forgiveness.

Yes, both of these programs require you to work in a low income school.  The good news is these are typically the easiest places to get jobs. It is worth it financially, and experientially. My best moments as an educator have come serving students and families at these schools.

For details on this program, visit Studentaid.gov at this link.

Public Service Loan Forgiveness Program (PSLF)

This program has much broader eligibility.  Generally, you only need to be employed by government or non-profits.  Most school employees qualify. But please use the link below to check if you are considering this method.

If you are eligible and make 120 consecutive payments (Yes, that’s 10 years) under a qualified repayment plan, the remainder of your loan will be forgiven.  

The 10-year length of time makes PSLF my least favorite option.  But, it may work best for your circumstances.

If you have significant student debt this program can also provide you the greatest benefit – by far!

To learn more about PSLF, click here.

Now, we hopefully made a sizeable dent in your student loan debt!  Getting better already, right?

Teacher FI and I were able to eliminate almost $40,000 of our ~$130,000 in student loans by using these programs.  The PSLF program wasn’t available at the time, but we paid off our remaining loans in less than 10 years, anyway.

Consumer debt is everything you borrowed to spend on stuff that isn’t your education or home.  This type of debt is typically higher interest and can include lots of hidden fees. You want to get rid of it as soon as possible, and then avoid it forever.  Especially credit card balances.

There are reasons to keep credit cards.   But your goal is to always pay off the balance each month.  If you can’t do this, you may want to cancel your credit cards as a self- control strategy for now.  

Okay, let’s get to eliminating consumer debt.  There are generally two approaches to attacking consumer debt.  Both require that list we made earlier. (See – it wasn’t just to create anxiety!)

First, before choosing a method understand that for either to work you need to stay current on all debt payments.  Skipping a payment on any debt will result in extra fees and increase the poison. Don’t do it!

Any student loan debt that you aren’t going to have forgiven, you should include in this list.

The Debt Snowball Method

This is the method Dave Ramsey advocates.  It’s not the method I would choose, but I acknowledge that Mr. Ramsey has helped lots of people get out of debt.  (Far more than I ever will even if I’m wildly successful.) He must be on to something.

To use this approach, sort that list of debt from the smallest to the largest AMOUNT OWED.  

Target the smallest debt first.  Put whatever extra money you have available towards paying down that debit.  Do this until it is eliminated.

Celebrate and repeat the process with the next smallest amount owed.   Each time you eliminate a debt, you are freeing extra money to apply to the next debt.  Hence, the snowball.

This creates a sense of momentum and motivation.  The downside is that you may be paying more interest and losing ground on other debt.

If you are someone that needs those tangible small wins to keep making progress, or are motivated by crossing things off, this is probably the method for you.

Debt Stacking (or Debt Avalanche) Method

For this method, sort your debt list from highest to lowest on INTEREST RATE rather than amount owed.

Reminder, continue to stay current with all required payments.  

Then, apply any extra money you can to the debt with the highest interest rate.  Continue to pay that debt down until it is eliminated.

Celebrate, then repeat the process.  Again, you have extra money to use each time you eliminate a debt.

The advantage of this method is that you are eliminating the debt that is costing you the most in interest.  Your overall savings is greater with this method. If you are able to persist, this will get you to zero debt faster.  

If you want to optimize your approach and don’t need the quick small wins, then this is the method for you.  

Choose whichever method will allow you to remain focused and follow through until your consumer debt is gone.  

Other methods

I want to quickly address that there are other methods that are more complex or involve legal choices.  Examples include using credit card balance transfers , home equity loans, debt consolidation or elimination, and even bankruptcy.  These may be appropriate or optimal for some. I prefer to avoid solving debt with more debt or defaulting on debt. I have chosen methods that will work for those who are able to create extra money for debt payment and lead to eventual repayment of debt obligations.

Teacher FI and I used student loan forgiveness and the debt stacking method to eliminate more than $170,000 in debt (including cars) over a period of seven years.  It was steady, but nothing extraordinary. We weren’t intentionally on the path to FI at the time – we just knew that debt was poison.

With intention, you can do it, too!  Probably faster.

Eventually, you will get out of debt.  Celebrate! Seriously, celebrate a lot.  Tell everyone you can! You have achieved a major step on your path to financial independence.  All of that money you were using to pay interest, or focused on paying down debt can now be put to work for you!

(Note:  A blog post like this is not sufficient to deal with significant debt challenges.  If you are struggling deeply with debt and despair, take action. Here is information on choosing a credit counselor.)

Don’t forget to check out my post on sinking fund examples for a powerful strategy to avoid getting back into debt and saving thousands in interest!

Next week, I’ll write about the two numbers you must start tracking for your FI journey.  Subscribe for updates.  I look forward to supporting your journey!

Update: Here is the index of the entire FI Basics Series if you’d like to hop around other posts in the series:

• Financial Independence Primer
• Dealing with Debt   (You are Here Now)
• Sort Your Spending to Speed Your Journey 
• Two Powerful Numbers to Track
• Setting Your FI Targets – How will you know when you are financially independent?
• Strategic Savings: Create, Secure, Deploy
• Investing: 5 Keys and 2 Examples