Debt & Loan Management

Debt Overview

Debt and loans can be good or bad depending on how you use them. Overall it's optimal to be on the safer side and bring your debt down to a manageable level, but having debt can be useful for a few reasons. The first is relatively obvious - debt allows you to buy things now with other people's money. While that can be very dangerous and addicting (credit cards debt is at all time highs!), taking out loans for a house, car, or education is common and if done properly, should be done. 

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The second is less obvious but is important, especially if you're in a higher tax bracket. Some forms of interest payments - mortgages, business loans, and student loans, can be deducted from taxes - meaning in the government's eyes you earned less that year and thus pay less in taxes (also called having a lower taxable income).

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The 3rd should really only be done when you're in a safe financial position, meaning having at least an emergency fund and no high interest rate debt. The 3rd piece is opportunity cost. Let's say you have a 30 year fixed mortgage on a house at 3%. The stock market (S&P 500), on average, has historically earned an 8.2% return. Even if you have enough money to buy back your mortgage, in some cases you shouldn't because you can use put that money in the stock market and, on average (not necessarily any given year), earn the difference between that 8.2% and 3%. 

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Types of debt (generally from highest interest rate to lowest)

• Credit Card

• Personal Loans (varies widely depending on your credit score, financial situation, and need for it)

• Auto Loans

• Student Loans

• Mortgage

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How to pay back expensive debt

• Refinancing: if your credit score of financial situation in general has improved since you took on the loan or interest rates are lower, you can speak to your lender (or other lenders) about consolidating your debt (taking some or all of your loans and putting them under one umbrella) or refinancing (taking one loan and getting a lower interest rate on that loan). Don't refinance if the fees for doing so are expensive, you'll have a higher interest rate, or you're close to the end of the loan term.

• Avalanche Method (my favorite): Pay off your debt with the highest interest rates. It might seem like you're making less progress but this will save you the most money in the long run!

• Snowball Method: Pay off debt with the smallest principal and interest amounts. If you're the type of person who gets motivated by checking things off your list, use this method.

• Taking on additional side gigs or ask loyal and trusted clients for better payment terms

• Lowering your expenses: Check out the budgeting section! Think about which expenses fall into the "want" category and can be lowered (even if it's temporarily) 

• If possible, don't take out expensive debt like credit cards

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5 C's of Debt: What a lender looks at when offering a loan and determining the interest rate and terms

• Capital: assets you can use to repay the loan

• Collateral: assets that can secured by the loan - meaning the lender can take these from you in the case of non-payment and default

• Capacity: income (as a freelancer, this is what lenders will typically think about most). It's not just the amount of income you have, but the consistency of it - the longer your history of consistency earning money, the better. If you don't have a long history of consistent earnings, try to lean on one of the other 4 C's to get loan and the best terms possible!

• Conditions: loan terms, amount, and misc. items like how risky the lender can afford to be

• Credit Score (see below)

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Credit Score

• Credit scores are important as they are one of five factors a lender evaluates when determining to issue a loan

• A better credit score can mean lower interest rates on loans, better loan terms, easier time getting a loan/apartment/house, more access to credit cards, and more

• Your credit score is a number that is decided by the following: Payment history - analyzing how often you pay loans back on time (35%), Outstanding amounts owed (30%), length of credit history (15%), new credit - analyzing how many loans you've taken out recently (10%), and credit mix - or having a history of paying back different types of loans (10%)​​​​​