Debt is often a difficult subject to discuss: as a financial tool, it can be leveraged to help you take advantage of new opportunities—but it can quickly become a burden that stunts your financial growth or puts added stress on your life. The Imagine America Foundation has compiled some of the most important information to help you navigate taking on debt, paying off debt, and how to use debt to maintain your overall financial health in this edition of our financial literacy series.
In an ideal world, we’d all have enough money to meet all our daily needs—plus fund the occasional vacation, buy a decent car, own a home . . . and continue our education. But as we know (sometimes too well), that’s not the case. So when you’re ready to find a career training program to help you on the path to a new job, you may not be prepared to pay for that straight out of your bank account. Borrowing money can allow us to pursue items and opportunities that would otherwise be out of our reach. The trick is to know how much money you can reasonably and sustainably borrow without putting yourself into a big hole and wreaking havoc on your financial future.
Any time you consider borrowing money, there are a few key factors you should definitely pay attention to: the loan amount or credit limit, the repayment schedule, the interest rate, and the fees.
This is the amount of money you’re borrowing, whether it’s a personal loan, an auto loan for a car, or student loans to cover tuition and other associated education costs. Similarly, your credit limit is the amount you’re allowed to borrow per your agreement with a financial institution (as in a credit card). The amount is determined by need and can vary depending on your situation: for instance, if you’re attending school and tuition is $1,000 per semester, you may want to borrow $1,000. But if you’re planning to live on campus and will need another $1,000 to cover those costs, you may opt to borrow $2,000 per semester.
With a car loan, some people opt to borrow money for the entire cost of the car. But if you have some money already saved up, you can pay a down payment upfront so that your loan amount is smaller—and that can also help you get a better interest rate.
Think of interest as the price you’re paying to borrow money. The more money you borrow, the longer you have it, and how responsible you’ve shown yourself to be with borrowed money in the past can all affect how much you pay to use someone else’s money. Interest rates for student loans can vary widely and can drastically affect your repayment program after school. It’s also important to know the terms of your interest: some loans accrue interest annually, quarterly, monthly, or even daily. As that interest builds up, you may start paying interest on your interest . . . and it can get ugly in a hurry. We recommend finding an interest calculator online or in your financial aid counselor’s office to help you have a clear picture of what you can expect to pay long-term.
In addition to interest rates, some loans may have other fees associated with them. Some credit cards charge an annual fee to have an open account, some banks charge a monthly fee for the duration of a personal loan, and nearly all loans will charge penalties for exceeding your limit, paying late, or not paying the required minimum due in a given billing cycle. As in all aspects of your money, and particularly when it involves a large sum that you’ll be paying off over a few or many years, make sure you know and understand what exactly you’ll be paying for and when.
It can be tedious and confusing to read the fine print, but it’s worth the time and trouble upfront to go through it and to ask questions before you sign.
Hopefully when it’s time to pay off your loans or your credit line, you’ve done your homework so there are no surprises and you didn’t borrow too much so you don’t feel overwhelmed by the road ahead. Often, that’s just not the case—but don’t lose hope! It can feel daunting when faced with that first bill after graduation, but we’re here to assure you that there’s a light at the end of the tunnel.
You might feel tempted to ignore the situation or choose to skip a payment, but it’s best to always keep paying no matter how small a drop in the bucket it might seem. Get into a routine and make sure all your loans (and any other debts) are included in your budget so that you’re always prepared to at least make the minimum payment every month. When you can, start paying more than the minimum and your payment plan will snowball until that debt is gone!
If you’re truly struggling to make the minimum payment on time, talk to your lender about your situation. Lenders are often willing to work with borrowers on adjusting the payment plan so that it works for them—they might rather have an agreed-upon plan to get a smaller amount of money from you each month, for instance, than having missed payments and needing to chase you down. Give them a call or set up a meeting to talk about your finances in honest detail and request some flexibility. If you show them a willingness to work with them on meeting the terms of your loan agreement, they’re likely to return the favor.
Debt and the Big Picture
There is a standard rule of thumb that you shouldn’t spend more than 30 percent of your monthly budget on housing, whether in rent or on a mortgage. Similarly, you should aim for no more than 20 percent of your monthly budget being required for debt or loan payments. If you’re able to commit more resources toward debt to pay it off faster, that is always a great idea—but this should be the minimum. If your minimum payments make up, say, half of your monthly budget, that leaves you very little margin when unexpected expenses arise or if you want to treat yourself to something outside your standard budget categories.
It can be easy to think of your student loans and other debts as a problem for the future, but doing a little extra homework and a little extra legwork in the beginning can help make repaying your loans feel like a breeze once you’ve graduated and have started the next chapter of your career.
Follow our blog for other helpful tips and information about maintaining your financial health. And don’t forget to look for the next edition of Career College Central: we’ll continue our financial literacy series with information about savings!