We know it might feel daunting and even a little scary to be in debt in your 20s. Don’t panic! Rather than bury our heads in the sand, let’s take a deep dive into taking control of your debt.
Get Organized
The first step to any debt management plan is to figure out exactly how much you owe. Grab a piece of paper, open up a spreadsheet, or try out an online account aggregation tool like Mint, Personal Capital, or Tuition.io (for student loans). List the type of debt, lender, current amount you owe (also known as the principal balance), interest rate, and minimum payment for each loan.
Understand Interest
When you take on debt, you agree to repay the original loan amount back over time plus interest, which usually accrues daily. Each time you make a payment on your debt, a portion is used to cover the interest expense that has accrued since your last payment. The remainder pays down your principal balance. Let’s say you have $5,000 in credit card debt at an interest rate of 18%. When you pay your minimum payment of $100 each month, $75 covers the accrued interest and $25 reduces your remaining balance. Now you owe $4,975. As you continue to repay your debt, the portion of your payment that goes to interest will go down and the portion to principal will go up. Why? Because there is less to pay interest on as you pay down the principal balance.
Stop Adding to Your Debt
If you’ve noticed your credit card balance creeping up, you may find it’s time to make a change and aim to live more within your means. The best step to taking control of your debt, especially credit card debt, is simply to stop adding to it! Take a hard look at how you’ve been spending. Most of us could find a few instances of mindless or convenience spending that may be easy to cut back on or even eliminate altogether. To resist the temptation to splurge, leave your credit card at home (you can even freeze it in a block of ice if it will help!), and consider adopting an all-cash system. Whatever the strategy, find one that helps you spend within your means and in a way that focuses on the things that you value most.
If You’re a New Grad with Student Loans, Take Advantage of Your Grace Period
You will not be required to make payments on your student loans during your grace period—the time between the end of classes, but before your first student loan payment is due. This period is usually six to nine months, depending on the type of loan. Even though you don’t technically have any payment due, you may want to act like you do. “Pay yourself” your monthly minimum and put this amount in a savings account. Not only will you get used to making room in your budget for this new financial obligation, you will also accumulate a nice little cash cushion along the way.
Pay a Little Extra Whenever You Can
Always pay at least the minimum payment each month in order to stay current, avoid late fees, and keep your credit history in tact. However, it never hurts to pay extra toward your highest interest rate loan if you can—even a little can go a long way. Remember that $5,000 in credit card debt at 18% interest we talked about earlier? Rather than paying the minimum payment of $100 each month, what would happen if you paid $120 per month instead? This seemingly insignificant increase would save you $1,400 in interest and the debt would be paid off two years sooner! Use a loan repayment calculator to see how you can benefit from increasing your own monthly payments.
Debt gets a pretty bad rap and it can feel overwhelming to find yourself in debt in your 20s. The best way to take on a daunting debt situation is to put a strategy in place to help manage it. Once you know all the details of your loans and exactly how interest works, you’ll be armed with the knowledge to tackle your debt head on and get on the road to being debt free.
This guest post was written by Karen Carr, CFP®, Society of Grownups. Any third party resources or websites referenced above are not under our control. We cannot guarantee and are not responsible for the accuracy of the resources, websites, or any products or services available through such resources or websites.