2873: Simple Answers to 7 Common Debt Questions by Chelsea of Smart Money Mamas on Saving Money

[00:00:00] [SPEAKER_00]: This is Optimal Finance Daily. Simple Answers to 7 Common Debt Questions by Chelsea of SmartMoneyMamas.com.

[00:00:10] [SPEAKER_00]: And I'm your host and personal finance enthusiast, Diana Merriam.

[00:00:14] [SPEAKER_00]: Now let's get right to today's post as we optimize your life.

[00:00:23] [SPEAKER_00]: Simple Answers to 7 Common Debt Questions by Chelsea of SmartMoneyMamas.com

[00:00:30] [SPEAKER_00]: Most financial blogs, this one included, focus on achieving a debt-free life.

[00:00:37] [SPEAKER_00]: However, most people aren't debt-free today and there are a lot of tough debt questions out there.

[00:00:44] [SPEAKER_00]: There are a lot of misconceptions out there about how debt works.

[00:00:49] [SPEAKER_00]: Understanding what to focus on and the mystery of credit score calculations is difficult.

[00:00:54] [SPEAKER_00]: So here's a quick roundup of simple answers to 7 common debt questions.

[00:01:01] [SPEAKER_00]: 1. Do I need to carry some credit card debt for a high credit score?

[00:01:08] [SPEAKER_00]: No! I'm not sure where this rumor came from, but my goodness it needs to die.

[00:01:15] [SPEAKER_00]: All you need for a strong credit score is a long-standing credit card that you use at least occasionally to keep it active.

[00:01:23] [SPEAKER_00]: You can pay it off in entirety each month and never pay a dime of interest.

[00:01:30] [SPEAKER_00]: The credit score agencies don't care whether or not the card carries a balance.

[00:01:35] [SPEAKER_00]: I got my first credit card, a Discover Cash Back card, in college.

[00:01:41] [SPEAKER_00]: I don't use it much anymore, but I won't close it as it's my oldest reportable debt.

[00:01:46] [SPEAKER_00]: I have it set to automatically donate money to Soldiers Angels every month to keep it active and it supports my credit score.

[00:01:55] [SPEAKER_00]: The main benefit of a high credit score is to allow you to get low-cost debt when you need it, for instance when applying for a mortgage.

[00:02:05] [SPEAKER_00]: You never want to pay high interest rates to keep the option for low interest rate debt.

[00:02:11] [SPEAKER_00]: Plus, you don't actually need to.

[00:02:14] [SPEAKER_00]: 2. Will paying off my debts lower my credit score?

[00:02:19] [SPEAKER_00]: Possibly. If you're paying off credit card debt and plan to leave the card outstanding, probably not.

[00:02:26] [SPEAKER_00]: If you're paying off student loans or a car payment where the account will be closed after the debt is paid down,

[00:02:33] [SPEAKER_00]: you might see a temporary decline in your score.

[00:02:36] [SPEAKER_00]: The decline will likely be more significant if the debt you're paying off is one of your longer-standing debts.

[00:02:44] [SPEAKER_00]: Longevity of your credit history impacts your score, so closing older accounts could drop your score.

[00:02:52] [SPEAKER_00]: In general, this shouldn't keep you from paying off your debts.

[00:02:57] [SPEAKER_00]: According to Vantage Score Solutions, it will typically take your score around 3 months to recover from a minor event like closing an account.

[00:03:07] [SPEAKER_00]: If you're planning on applying for a mortgage or will otherwise need to use your credit score within the next 3 months,

[00:03:15] [SPEAKER_00]: you could pay down the debt to a minor level, $50, and wait to completely close the account.

[00:03:22] [SPEAKER_00]: 3. Should I stop using credit cards completely?

[00:03:27] [SPEAKER_00]: How's your self-control?

[00:03:29] [SPEAKER_00]: If you have a habit of running up more credit card expenses than you can pay off each month,

[00:03:34] [SPEAKER_00]: you might want to tuck those cards away for at least a few months.

[00:03:39] [SPEAKER_00]: Use cash or a debit card until you can get your spending under control.

[00:03:43] [SPEAKER_00]: Otherwise, if you spend responsibly and can pay off your balance every month, you should absolutely keep using credit cards.

[00:03:52] [SPEAKER_00]: I pretty much exclusively use credit cards. It's so easy to track the expenses for budgeting.

[00:03:59] [SPEAKER_00]: Most cards offer payment protection, and I love the rewards points.

[00:04:04] [SPEAKER_00]: In my opinion, cash budgeting systems are for the birds.

[00:04:07] [SPEAKER_00]: If you can stay on budget and avoid carrying a balance, a credit card is a great tool.

[00:04:14] [SPEAKER_00]: 4. Should I invest or pay down debt?

[00:04:19] [SPEAKER_00]: Mathematically over the long term, if your debt has an interest rate below 6%,

[00:04:24] [SPEAKER_00]: you could focus on investing for retirement instead of paying down debt.

[00:04:29] [SPEAKER_00]: The long-term, 30-plus year stock market return is 7%,

[00:04:35] [SPEAKER_00]: and your net worth will be higher if you invest first and pay down debt later.

[00:04:41] [SPEAKER_00]: However, the functional answer isn't that straightforward.

[00:04:46] [SPEAKER_00]: Choosing whether to invest or pay down debt is about your risk tolerance.

[00:04:50] [SPEAKER_00]: I know people who would rather pay down a 3% mortgage than invest

[00:04:55] [SPEAKER_00]: because owing anyone money makes them uncomfortable.

[00:04:59] [SPEAKER_00]: Alternatively, China has a problem where its citizens are borrowing money at double-digit interest rates to invest in the stock market.

[00:05:08] [SPEAKER_00]: My rule of thumb is to first secure a decent emergency fund,

[00:05:13] [SPEAKER_00]: then pay down high interest like over 9% or variable rate interest debt,

[00:05:20] [SPEAKER_00]: and then make sure you're putting away at least 10% for retirement.

[00:05:24] [SPEAKER_00]: After that, it's up to you to decide if you want to grow your nest egg or pay down debt.

[00:05:31] [SPEAKER_00]: The math often says invest, but if the economy turns and you're out of a job,

[00:05:37] [SPEAKER_00]: that debt you didn't pay off could haunt you.

[00:05:40] [SPEAKER_00]: 5. How often should I check my credit score?

[00:05:45] [SPEAKER_00]: At least once a year.

[00:05:46] [SPEAKER_00]: I check my score about quarterly, just to make sure I don't see any accounts or inquiries I don't recognize.

[00:05:54] [SPEAKER_00]: If you're planning on applying for a new job, buying a house, or refinancing debt,

[00:06:00] [SPEAKER_00]: I recommend checking your credit score a few months before these events.

[00:06:05] [SPEAKER_00]: This will give you the opportunity to dispute anything on your account that you believe is incorrect

[00:06:10] [SPEAKER_00]: and find ways to increase your score before you need it.

[00:06:15] [SPEAKER_00]: 6. When should I consider debt consolidation?

[00:06:19] [SPEAKER_00]: If after necessary living expenses and minimum debt payments,

[00:06:24] [SPEAKER_00]: you have no income left over for debt reduction,

[00:06:27] [SPEAKER_00]: you may want to consider a debt consolidation loan to lower your interest rates.

[00:06:33] [SPEAKER_00]: However, if you choose to go down this route,

[00:06:36] [SPEAKER_00]: make sure you have made real moves to change your spending habits long-term.

[00:06:40] [SPEAKER_00]: A debt consolidation loan isn't going to help you get out of debt if you keep spending more than you make.

[00:06:47] [SPEAKER_00]: Debt consolidation loans used to be popular to help reduce complexity.

[00:06:51] [SPEAKER_00]: When you were getting six different bills in the mail

[00:06:54] [SPEAKER_00]: and had to remember to pay each one with a handwritten check,

[00:06:58] [SPEAKER_00]: moving to one loan sometimes meant late or missed payments.

[00:07:03] [SPEAKER_00]: But in the age of the internet, I think the reduced complexity argument is weak.

[00:07:09] [SPEAKER_00]: In only a few minutes, you can set up auto payments for your debts.

[00:07:14] [SPEAKER_00]: Multiple loans also mean that as you pay down the debt,

[00:07:18] [SPEAKER_00]: you get the satisfaction of closing an account through your journey to a debt-free life.

[00:07:23] [SPEAKER_00]: The motivation of seeing six accounts go to five is worth more than you may think.

[00:07:30] [SPEAKER_00]: 7. I can't pay my student loans. What can I do?

[00:07:34] [SPEAKER_00]: Federal student loans have options for income-based repayment plans.

[00:07:40] [SPEAKER_00]: These plans lower your required payments in line with your current income.

[00:07:45] [SPEAKER_00]: This also, understandably, increases the amount of time it will take you to pay off the debt.

[00:07:51] [SPEAKER_00]: However, it still may be a good source of relief if you can't make ends meet today.

[00:07:57] [SPEAKER_00]: Unfortunately, in most cases, student loan debt can't be discharged or canceled.

[00:08:02] [SPEAKER_00]: Because of the option for income-based repayment,

[00:08:06] [SPEAKER_00]: student loan debt is very hard to discharge, even in bankruptcy.

[00:08:11] [SPEAKER_00]: You have to prove that not only can your income not pay down the debt today,

[00:08:16] [SPEAKER_00]: but that your lifelong earning power can't satisfy the debt.

[00:08:21] [SPEAKER_00]: I would recommend pursuing an income-based repayment plan

[00:08:24] [SPEAKER_00]: before considering refinancing or consolidating into a private loan.

[00:08:29] [SPEAKER_00]: Private student loans are not required to have the same borrower protections as federal student loans.

[00:08:36] [SPEAKER_00]: You could end up even more stuck than you started.

[00:08:44] [SPEAKER_00]: You just listened to the post titled

[00:08:46] [SPEAKER_00]: Simple Answers to 7 Common Debt Questions by Chelsea of smartmoneymamas.com

[00:08:53] [SPEAKER_00]: and I'll be right back with my commentary.

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[00:09:57] [SPEAKER_00]: I noticed that this article focuses a lot on questions around credit scores,

[00:10:03] [SPEAKER_00]: and it reminds me of a time when I mistakenly overvalued my credit score.

[00:10:09] [SPEAKER_00]: A good credit score is really only helpful when you need a loan,

[00:10:13] [SPEAKER_00]: and in some cases, landlords, insurance companies, and employers may take a peek at it.

[00:10:18] [SPEAKER_00]: But a dip in a credit score as a result of a good financial choice,

[00:10:24] [SPEAKER_00]: like paying down debt or closing accounts, shouldn't affect your choices.

[00:10:29] [SPEAKER_00]: When you make good financial choices, your credit score will reflect that over time,

[00:10:35] [SPEAKER_00]: so don't let the tail wag the dog.

[00:10:38] [SPEAKER_00]: A high credit score does not necessarily mean that you're financially secure,

[00:10:42] [SPEAKER_00]: nor does a low credit score mean that you're in financial trouble.

[00:10:45] [SPEAKER_00]: A credit score is just one aspect of your financial picture,

[00:10:50] [SPEAKER_00]: and it's important to understand its limitations.

[00:10:53] [SPEAKER_00]: I've since come to realize that the number that really matters is my net worth,

[00:10:59] [SPEAKER_00]: because it's much more comprehensive and it can capture long-term trends.

[00:11:04] [SPEAKER_00]: It's important to remember that net worth is not a static figure.

[00:11:08] [SPEAKER_00]: It evolves over time, reflecting the cumulative result of financial decisions.

[00:11:14] [SPEAKER_00]: Net worth encompasses savings, investments, and property,

[00:11:19] [SPEAKER_00]: offering a nuanced gauge of financial stability,

[00:11:23] [SPEAKER_00]: whereas a credit score really only provides insight on your ability to manage debt.

[00:11:28] [SPEAKER_00]: But that will do it for today.

[00:11:30] [SPEAKER_00]: Have a great day and weekend,

[00:11:32] [SPEAKER_00]: and I'll be back here tomorrow as usual, where your optimal life awaits.