Smart Money: The Step-by-Step Personal Finance Plan to Crush Debt

Step 1 › Figure Out What You Owe

Debt has a scary connotation, but it’s pretty simple when you boil it down. What is it, exactly? Debt is money borrowed from a person or institution that you must repay. Usually people take on debt if they are not in the financial position to pay for a purchase upfront. Instead, they borrow money to pay off the purchase over time, with interest. This means when you borrow, you do so at a cost. You’re literally paying for the time it takes you to pay off that owed sum.

It goes back to the schoolyard. Someone asks, Hey, man, can I borrow 50 cents for hot Cheetos? The person responds, Sure, dude, if you pay me back 75 cents. You get the hot Cheetos when you want them, but since you had to borrow the money to purchase them, you owe a fee for the time it took to pay off your debt. Your lender, in this case your friend, gets rewarded for having the funds from the jump. (This is how wealth begets wealth, but more on this later.)

The unfortunate truth is that this generation is facing more debt than any other in recorded history. I’m talking about four-comma debt. Over a trillion dollars, according to the Federal Reserve Bank of New York. That’s more than the net worth of all the billionaires in this country combined.

Getting clear on to whom we owe money is the first step toward financial freedom. It’s tempting to downplay our debt, because debt has become super normalized. We all have that uncle who still has student loans from the ’70s. But the normalization of debt is dangerous. In fact, it has led this country into a debt crisis. The average American household carries over $8,000 in credit card debt alone. I’m here to tell you that this is something we have to tackle head-on. That’s why figuring out what you owe is Step 1.

You may have heard some well-meaning money advisor tell you to focus on the money you’re making. This is a little easier to digest, and it’s also where they make their money. But I’m here to give it to you straight. Debt is an issue you need to tackle now so that you can grow your own money. It’s real, but it also isn’t all doom and gloom. Taking control of debt is how you take back your power. In this section we’ll cover:

♦Is all debt the same?

♦Your credit score and its power

♦Credit card debt

♦Student loan debt

♦Other meaningful loans

♦One step at a time

Is All Debt the Same?

Debt isn’t inherently good or bad. It can be used to get ahold of things when you need them (à la hot Cheetos), or leveraged to help you build wealth. Left unchecked, debt can turn on you fast. Alas, not every form of debt is created equal.

Debt is classified into two categories we generally call secured or unsecured debt. With secured debt, there is an asset—like a car—backing your loan. For an unsecured loan, there are no collateral assets necessary, meaning it’s just your credit score (and lending attractiveness) on the line. Credit cards are a common example of an unsecured loan. Although you can’t lose your house or car immediately for nonpayment of an unsecured loan, there can be serious repercussions. Not paying your debt, or even paying late, could cost you more in the long run.

Below are the most common types of debt, interest rates, terms, and consequences of not paying off your debt quickly. I also created a scariness factor cheat sheet to ensure you understand the potential risks of each debt type (see the chart here).

If you’ve got debt, and there’s a good chance you do, you’re taking the first important step to eliminate it by looking closely at it. It might be painful, but you have to know what’s in front of you to tackle it head-on. Let’s take a look at what’s in your closet.

Hella Scary Debt: Work on eliminating this debt the soonest.

Scary Debt: Attack this type of debt as soon as possible, but after the hella scary debt.

Okay Debt: Pay down this debt while stacking cash and investing.

Credit card debt is probably the costliest type of debt you have. Interest rates fluctuate between 6 and 29 percent according to your credit score. Balances can rack up when you don’t pay off what is due on a monthly basis, and your credit score can take a hit. Furthermore, if you default on your credit card, you can be sued or face wage garnishments, which is when creditors take a portion of your paycheck. I classify this as Hella Scary Debt.

Student loans can be federal or private debt, and the terms vary. The generation currently in their 20s and 30s has a higher student loan debt burden than any prior generation. The average amount of student debt a person carries is $33,000, according to Investopedia. These loans typically have interest rates on the lower side, from 4 to 7 percent. If you don’t pay the money back, creditors can’t take away your degree, but they can make life hard. You can lose access to beneficial federal repayment programs, like loan forgiveness or deferment. You can also be sued, have tax liens, or have your wages garnished. But there are several actions you can take to remediate if you can’t pay off these debts, so I classify them as Okay Debt.

Car loans are often calculated by what you can afford monthly, not necessarily based on the total car price. This creates a sense of false affordability as car loan terms stretch out longer and longer. Interest rates vary based on your credit score, the term length, and whether the vehicle is new or used. Interest rates can be as low as zero percent or as high as 20 percent. I classify car loans as Okay to Scary, depending on the terms. The total price you pay, and the interest rate variations, are like the Wild West. Proceed with caution.

Personal loans are often a catchall to get quick access to funds. They’re used for anything from home remodels to emergency payments, and rates are between 5 and 36 percent. I want you to think about that for a second. Would you borrow $100 from your friend if they asked you to pay them back $136? What if that interest compounded over time because you couldn’t make the first repayment, so now you owe 36 percent on $136? The bigger the interest, the riskier the loan—and the more the lender is counting on you to default, hitting you with additional fees and unmanageable repayment sums.

If you can’t afford the upfront amount, chances are you’re living outside of your means, and the system is counting on you to fail. Sure, the terms for personal loans may be shorter, around two to five years, but there is risk nonetheless. I classify personal loans as Scary Debt because they are often used as a crutch. Personal loans usually substitute for saving cash for purchases or paying off debt. Not paying these loans back quickly will potentially wreck your credit, get you sued, and lead to wage garnishments—not to mention the opportunity cost of not using these repayments to invest.

As you can see, not all debt is created equal. Rates, terms, and default consequences vary. Having zero to low debt is your best bet in any case. Remember, the more money you’re spending on paying someone else back, the less you have to build your wealth. Here’s an easy chart to summarize the different types of debt before we dive deeper into each one.

Your Credit Score and Its Power

Cash is queen. (Yes, queen. Hi, 21st century.) But credit is pretty darn important, too, because it’s your financial street credibility.

A healthy credit score helps free up cash and get you into the hippest neighborhoods. This is because your credit score is seen as a reflection of your trustworthiness, or your ability to pay money back when you say you will.

Credit scores tell lenders if you can responsibly borrow from them before you even step into their office. It’s like a report card that gives you a grade between 300 and 850. The ranges are broken down below, and my goal is to get you to Excellent, if you’re not already there.

750 – 850: Excellent

700 – 749: Average to very good

640 – 699: Fair

600 – 639: Poor

Below 599: Bad

You’ll notice slight variations with every score you pull. Lenders look for different information depending on what they are qualifying you for. Your score will look different when you’re applying for a mortgage than when you’re applying for car insurance.

There are free personal finance sites like NerdWallet, Credit Karma, and Credit Sesame that will give you your credit score. Try to check your credit score often so you know where you stand—I check mine at least once every couple of weeks. Super important to note: Checking your own score does not damage your credit.

A good credit score opens up a world of options and opportunities. This is how you can get zero percent interest on car loans and credit cards. It can give you a leg up on the competition when applying for certain jobs, because sometimes prospective employers run a credit check. A good credit score also gets you those sweet interest rates when it comes to buying big-ticket items like a home.

With a lower score, you have to put in more work to prove yourself, or lack access to loans and other services altogether. Most landlords won’t consider you if your credit score is poor. A low score often means paying a larger deposit for housing, a new iPhone, or even to get your lights turned on. It means having to ask your auntie to cosign for your car. Ultimately, you have to pay more on average for every dollar you borrow when you don’t have good credit. That’s how the cycle of creditors taking advantage of people begins.

RUNNING YOUR CREDIT REPORT

Your credit report contains the ingredients that make up your score. In essence, it is a detailed history of your relationship with lenders. It contains personal information, credit account history, credit inquiries, and public records. Lenders and creditors report this information, used to generate credit scores, to credit bureaus.

Your credit report lists:

♦What types of credit you use (credit card, mortgage, car payment, etc.)

♦The length of time your accounts have been open

♦Whether you’ve paid your bills on time

♦How much credit you’ve used

♦Whether you’re seeking new sources of credit

♦Information on where you live

♦Whether you’ve been sued or arrested

♦Whether you’ve filed for bankruptcy

There are three main bureaus that report your credit history: TransUnion, Equifax, and Experian. Each has its own method of reporting and generating scores. Why three agencies that do the same thing? For good ol’ checks and balances. If something looks incorrect on one report, you can point lenders to another.

By federal law, you have access to your reports from all three bureaus through AnnualCreditReport.com, a government-authorized site. This access is free at least once a year. Check it today and then create a reminder to do this once a year. Downloading an app from one of the major credit bureaus is also a great way to catch errors and guard against identity theft.

It’s imperative to know how to access and interpret credit reports. If you skip this section, you might as well toss out this book. When you go to check your credit, you’ll need to provide personal information to verify your identity. They’ll ask for your name, Social Security number, address, and birthdate. If you’ve moved in the last few years, you’ll need past addresses.

Once you’re granted access to your reports:

♦Print them out or save them as PDFs. Scan them for mistakes.

♦Make sure all accounts are ones you signed up for or authorized.

♦Check for any negative information that’s not correct.

♦If you have any negative accounts—severely delinquent accounts like late payments, debt collections, charge-offs, and repossession—you should know that those accounts fall