For most of us, the New Year brings resolutions around two things: Waist tightening, and wallet tightening, as November and December seem to be splurge-y on all fronts. Money, in particular, is hard to get a handle on, especially if you have looming and recurring monthly incidentals that are non-negotiable. Farnoosh Torabi, the host of the informative and conversational daily podcast, So Money, spends the 30 minutes dissecting a money topic via a frank chat with a leading business mind/author/influencer. And on Fridays, Torabi—herself a knowledgeable financial expert, author, and TV personality—answers listeners’ most pressing financial questions. She covers a wide range of subjects, and has a particular knack for breaking down debt and coming up with solutions that actually work—having climbed out of her own $30,000 hole earlier in life. Below, some tips on getting spending, and debt, under control.
A Q&A with Farnoosh Torabi
What’s the number one cause of debt in this country, and how many of us are affected?
Debt stems largely from financial illiteracy, i.e., not knowing how to manage money and credit properly, or how to live within one’s means and save. The idea of having something now and paying for it later is incredibly attractive, too. Unfortunately, we don’t always understand the ramifications of taking on debt and how we’ll be able to really pay it off.
Many Americans have some sort of debt, whether it stems from credit cards, student loans, a mortgage, auto loan, personal loan, or a combination. Medical debt is also a growing burden and a leading cause of bankruptcy in the United States.
Can you explain the difference between good debt (i.e., a mortgage that’s manageable), versus crippling debt? What are the scenarios when it makes sense to borrow money?
You could call a mortgage “good” debt in that it is a loan for a home, an asset that could appreciate over the long run. It’s also an asset that has the potential to serve you and your family well and improve the quality of your lives. Student loans with their relatively low interest rates and support of higher education may also be seen as “good.”
It can make sense to borrow money when attending college, buying a home, or starting a business—but you must be smart about the amount you take on. As a rule of thumb, try to keep student loan borrowing to no more than your estimated starting salary out of college. For home loans, go for a mortgage that keeps your monthly payment to no more than 30% of your take-home pay.
High interest rate credit card debt would fall in the bad category. It’s a more expensive type of debt due to the higher interest rate. And if you just pay the minimum each month you may be in debt for countless years paying loads in interest. Carrying large amounts of credit card debt can also weigh heavily on your credit score, more so than a mortgage or student loans.
But here’s the thing: Poor management of debt—good or bad—can turn even the friendliest of loans, such as low interest federal student loans, into an absolute nightmare. Late payments can trigger massive fees and a ballooning balance.
Are there basic, one-size-fits-all rules for getting out of debt? Anything that’s particularly effective in terms of enabling successful saving.
I have a list of ways to crush debt that everyone can use.
Face your fears. Don’t ignore your debt. Don’t pretend it doesn’t exist. Face the truth and add up every penny you owe. If you have lots of little debts you may not even know how much it all adds up to. This can be scary. This can be emotional. But understanding the harsh consequences of remaining in debt should give you motivation to reverse your situation.
Attack credit cards. Start with your card carrying the highest interest rate. Mathematically speaking, that’s your most expensive debt, so it’s best to get rid of that first. Put most of your disposable income towards that credit card and do the best you can with the other cards, until that one is paid off, while paying at least the minimum on remaining cards. Then, begin to be more aggressive with the next credit card bearing the highest rate. A free website like Ready For Zero can help you create an action plan and follow your progress.
Pay more than the minimum. While your monthly statement says you only need to pay the minimum, understand that at that pace you could be in debt for several years and in the process pay hundreds, even thousands of dollars in interest payments. The best thing to do is to pay double, triple, quadruple the minimum.
Refinance. If your mortgage has an interest rate of 5% or more and you plan to live in the home for at least another three to five years, you may be a strong candidate for refinancing your mortgage. Start by contacting your lender and asking about your options. Compare that to other bank offerings, as well as credit unions and smaller banks, which may offer more generous deals. Make sure the cost doesn’t outweigh the benefit of refinancing.
Automate. Pay your bills on autopilot, everything from student loan payments to your mortgage to credit card statements, all to ensure you don’t fall behind on payments and face ballooning balances. You may even get rewarded in some cases for automating payments. Automating student loan payments, for example, earns you a 0.25% interest rate reduction.
What should people do in the short-term to get out of the debt? And in the long-term?
In the short-term, prioritize your debt by attacking the balances with the highest interest rates first. Pay more than the minimum balance. Check the back of your credit card statement where the bill will highlight how long it will take to get out of debt in the next three years. Most people don’t know this trick but it’s a great roadmap to set up an effective re-payment strategy.
Then try to slowly get on a system of paying off that monthly card balance automatically in full. Never let a balance carry over to the next month.
And speaking of automation, setting up automatic savings will help you get on a healthy road to financial success over the long run.
Should getting out of debt be the number one priority, or should you simultaneously try to buy a house, or set up a college fund for your kids, or save for retirement? What’s the priority list there?
Paying down debt should be a priority but don’t completely neglect saving for future goals either. Be sure to pay at least the minimum on all balances and a little extra towards the high interest rate debt first. From there, dedicate a small portion to saving for a rainy day and retirement. Once the debt is clear, pretend it still exists and continue allocating that same monthly payment you were putting towards debt towards savings goals.
Once you’ve successfully climbed out of debt, what are the basic rules you need to live by to ensure that you don’t fall back into debt?
Limit credit card spending to an amount you can easily pay off every month in full.
Track your spending so that you can be more conscious of where your dollars are going. Just like writing down your meals when trying to manage your weight, writing down your spending will help you have a better understanding of where your money is going. And whether you should change course.
Automate your credit card payments. Never miss a bill payment this way.
Save at least 10% of your income. Commit to an automatic savings plan. Dedicate saving at least 10% of your take-home pay in a plain vanilla savings account. Save until you have about six to nine months of living expenses shored up. This way if you hit a rough patch you don’t have to tap your credit cards again and live on debt.
Do you have any favorite budgeting apps or tools?
One automated savings app that’s really cool is Digit. The founder Ethan Bloch stopped by my podcast So Money to explain more about it. Basically, it’s an automated savings tool that has text-enabled communication. It connects to your checking account and then the app analyzes your income and spending habits to find small amounts that it will automatically save for you. If you decide you want to tap into that savings, you can take out from it without incurring any fees.
I also recommend checking your credit profile at least once a year. You can do so for free at Annual Credit Report. There you can check your credit report from each of the three major credit reporting agencies. You should also check your credit score, especially if you’re in the market for a loan. Your bank may be able to provide you with your score for free. For example, I’m a financial education partner with Chase Slate and they provide card members their FICO credit scores for free, along with all the positive and negative factors impacting their scores. It’s incredibly helpful to know where you stand and the specific steps you need to take to improve your credit health. A strong credit score can mean lower interest rates for you and thousands of dollars saved in a lifetime.
Does it ever make sense to pay a financial planner to help you get out of debt? Are there free resources?
A credit counselor may be a more appropriate person to work with to help you get out of debt. The National Foundation for Credit Counseling and Money Management International are two great resources. The first meeting and consultation is absolutely free. Counselors there may then recommend you join a debt management program, which sometimes carries a small monthly fee. Credit counselors work on your behalf to modify your debt or help you pay down your debt over time. If you’re really in a bind, the fee may possibly be waived. There are also free sites like Ready For Zero where you can create a personal plan for getting out of debt. The site tracks your progress and you can follow along with its mobile app.
Do you have any simple cost-saving tips that you can share?
Ask for a discount.
Buy in bulk.
Search for coupon codes.
Instead of trying to pare down costs, I like finding a side hustle or earning a little extra money each month. Websites like TaskRabbit and Gigwalk offer odd jobs that you can do around your city for some extra money.