Class #2 Notes: Managing Your Debt
In week two of our five week back-to-school personal finance program, we took on debt. According to a recent SoFi survey1, 45% of respondents plan to pay down their debt in the next five years, so we wanted to make sure everyone is equipped with the tools they need to make this goal a reality.
It’s easy to become overwhelmed when you have debt to repay, but there is good news: debt isn’t an end all. As we learned, not all debt is created equal. There’s good debt, there’s bad debt, and there are a variety of strategies we can leverage to tackle all of it. Let’s have a refresh of what we covered:
Your next money move:
In order to understand where paying down debt falls on your priority list, you first need to identify where you stand financially. In our course, we learned of eight chronological steps to take to help you better build a strong financial foundation: Building a Safety Net, Getting Matched, Protecting Your Income, Attacking Bad Debt, Building an Emergency Fund, Saving 15% for Retirement, Saving for Other Goals, and Paying Down Good Debt.
By understanding the importance of accomplishing these steps chronologically, we are able to focus on the right goal. Identifying which step of Your Next Money Move you’re on allows you to put all your effort into the right goal and accomplish it as quickly as possible, which then allows you to move on to the next stage with a strong foundation.
Paying down debt:
Before we can begin to pay down debt efficiently, we need to understand the different types of debt. For example, as you learned in the first session, “bad” debt (Interest Rate >7%) can accelerate consumption and easily hinders your paydown progress, and “good” debt (Interest Rate <7%) can increase your ability to earn or save and help you get ahead in life. Once you have an idea of what type of debt you have, you may want to structure your debt. This can come in various forms and may include: Consolidating (combining multiple existing loans); Restructuring (transferring debt from one account to another); and Refinancing (paying off existing loans with a new loan of the same kind).
By now, you should have a solid understanding of the various types of debt you have so we can move on to establishing a game plan on how you’ll begin paying it down. The most common strategies often used include the Snowball and Avalanche methods.
That said, we like to combine the best aspects of the snowball and avalanche methods, resulting in The Debt Fireball Method. This strategy takes a hybrid approach to the traditional methods of paying down debt. We call it the fireball method because it can help you blaze through costly bad debt faster so you can accomplish the things that matter most to you. The steps include:
• Categorize all debt as either “good” or “bad.” (Debts with a less than 7% interest rate are “good.” Debts with a higher than 7% interest rate that do not have the potential to increase your net worth are considered “bad” debt under this method.)
• List “bad” debts from smallest to largest based on their outstanding balances.
• Make the minimum monthly payment on all outstanding debts, then funnel any excess funds to the smallest of your “bad” debts.
• When that balance is paid in full, you’ll go on to the next smallest on the bad-debt list. Torch those balances until all your bad debt is repaid.
We hope you now have a solid understanding of your debt and the various strategies to help pay it off after joining this session. At SoFi, we offer various resources to help you better understand debt, including a credit card interest calculator. You may have an idea of what your interest rate is, but by the time you’ve paid off your credit cards, you could be shocked to see how much those interest payments have added onto your bill.
Set your reminder to tune into our next class on Wednesday, September 23 at 12pm PT/3pm ET with Brian Walsh, CFP® at SoFi, where you’ll learn the basics of investing, and so much more. And remember, if you want to learn more on how to manage debt or create a special plan for yourself, SoFi members can schedule a session with any of our SoFi Financial Planners here.
Thanks again for joining us this week and we look forward to seeing you again!
1Survey conducted via SurveyMonkey of 1,230 people ages 18 to 74 during August 19, 2020 to August 20, 2020.
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC .
Third Party Trademarks: Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.