If you’ve clicked through from Part 1 (if you didn’t, this makes it easy enough!), you’ll know that we’ve discussed the difference between “good” and “bad” debt, and how Gen Y-ers like us often make the mistake of confusing the two.
Here’s the solution to that problem.
Make your bad debts better
So, here’s the deal: You’ve got bad debt and good debt, but it doesn’t matter either way—you’ve got to pay both of them back, and that prospect is not looking too rosy. Are you screwed forever?
Not necessarily. Jim Yih, a financial advisor, best-selling author and syndicated finance columnist who runs the website wealthwebgurus.com, suggests moving your money from high interest debt to lower interest debt to cut down the interest rate. “Open up a line of credit, which has a much lower interest rate than a credit card, and move the credit card balance to the line of credit.”
Doing this will not only eliminate the interest rates sapping all your savings, but it’ll streamline the process by allowing all of your bad debts to be aggregated into one account. Yih is quick to warn though that this doesn’t have any bearing on tax deductibility, so your bad debts are still bad debts—just with slightly better interest rates.
The art of debt repayment
Let’s say you’ve got the bad debt under control and have been successfully managing your line of credit. Great—until you graduate and realize that you have another loan payment hurdle ahead. The issue then turns to which loan you should pay off first.
Instinct dictates getting rid of the biggest number first, since it seems like the heaviest burden and eliminating it will undoubtedly give you a huge psychological boost. Thus, for most fresh grads, student loans are usually the first order on the payback agenda.
But while most are too busy trying to write off their educational funding, they actually could have gotten some of their money back had they considered the aforementioned tax deductibility. Vancouver-based finance blogger Youngandthrifty says, “Gen Y tends to pay the student loan off before the car loan … but the thing is, the interest on the student loan at least gives you some money back in the form of a tax return, but the car loan doesn’t.”
Before deciding which of your loans to pay off first, find out which ones grant tax refunds from paying back interest or principal. Aim to pay back those without the tax break first, but contribute as much as you can to the other loans to take advantage of the returns you’ll receive from them.
The “best” debt secret
Freelance writer LaToya Irby’s own student debt story sheds light on the fact that while getting mired in debt is universally inadvisable, it happens to the best of us. “I graduated college with about $10,000 more in student loans than I had to. When friends told me I could borrow additional student loans and use it to pay for rent and other things, I jumped at the chance for extra money. But now, I’m paying that off. I could shave seven to 10 years off my student loan repayment if it wasn’t for that extra $10K.”
The most important thing to remember is to keep your priorities straight, especially in terms of your finances.
Yih points out that all debt, even the “good” ones, are only as beneficial as you choose to make them. “It all comes down to how you define good debt and bad debt. Ask yourself: what are you using the money for? Buying a car on credit so you can drive to school is a way to justify its purchase, but I wouldn’t consider that good debt. Eating out for lunch everyday on your credit card because you’re busy at school isn’t good debt.”
Even “good” educational debt isn’t great all the time, according to Yih. “If you can increase your income or earning power, then education makes sense. But some people take courses just to feed their interests or hobbies, so borrowing for those purposes may not be smart.”
The best lesson, he says, is this: only borrow what you can manage. “What students need to know is that debt always has a future consequence.” His tips for struggling young Canadians? Don’t amortize debt for too long. Live within your means, not your future potential means.
And of course, “the best debt—is no debt!”
Sound advice, indeed.