Rich Girl Roundup: The Debt Deep-Dive—And How to Strategically Tackle Each Balance

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Credit cards, lines of credit, student loans—debt is a normal part of life. How should we prioritize our debt(s), and what’s the best way to pay them off?

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Our show is a production of Morning Brew and is produced by Henah Velez and Katie Gatti Tassin, with our audio engineering and sound design from Nick Torres. Devin Emery is our Chief Content Officer and additional fact checking comes from Kate Brandt.

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Transcript

Transcript

Intro:

Rich Girl Roundup. Love it.

Katie:

Welcome back, Rich Girls and Boys to the Rich Girl Roundup weekly discussion of the Money with Katie Show. I'm your host, Katie Gatti Tassin, and every Monday we dig into an interesting money discussion. Here's a quick message from the sponsors of this segment. Before we get into the roundup, this week's upcoming main episode is a titillating debate style conversation with a CFP. Yes, someone with an actual license will be on the show for a change about the traditional versus Roth 401(k) question that we love to cover, so don't miss it. All right, onto the roundup. Henah, what is our question this week?

Henah:

This week's question came from a number of different readers and listeners we've compiled. So the larger question is what's the best way to tackle debt and is it as bad as everyone makes it out to be? Just as a reminder, this is not financial advice and we are not licensed financial professionals, so please do your own due diligence. So first I think both of us should be clear that debt, whether through credit cards, car loans, personal loans, HELOCs, debt's very normal and according to the Urban Institute, I think it's at 64 million Americans carry credit card debt alone. This is not something that we are trying to shame anyone about and often debt at least to me, always feels like a necessity for making ends meet for folks or accessing education to unlock bigger wins later. I actually wanted to ask you, Katie, because you published a piece maybe a year and a half ago, two years ago that really reframed how I saw debt. I think it was called, so rich people love debt-

Katie:

Ah, yes.

Henah:

... why do we hold it against everyone else or something along those lines. Tell me about that.

Katie:

Yeah, so I noticed that rich people seemed to have a very different relationship with debt and they called it leverage instead, which sounds way sexier. Now of course they are employing it in a strategic way, but my article was really in reference to a Wall Street Journal piece that came out called Buy, Borrow, Die and it was a big splash a few years ago, but it highlighted how the wealthiest people alive were taking advantage of the low interest rates. They were borrowing against their own wealth at super low rates rather than cashing out their investments and paying the 20% capital gains taxes on their gains. They were basically keeping it there so it would grow and then getting a loan at a rate of 3% instead of 20% and spending that. And so the point is debt can be a valuable tool, but it's like leverage, often a double-edged sword.

Henah:

Yeah, I agree. The way you wrote it really changed how I felt about it. For this conversation I think maybe we can start with a general framework about the different kinds of debt and comfort levels.

Katie:

When I think about frameworks for debt, I broadly bucket it into high interest and low interest debt and what that practically means for people typically is when they're talking high interest debt they usually mean credit card debt though sometimes things like subprime auto loans or other consumer loans will inch into that high debt territory like think double-digit interest rates. And then I also would say the second bucket is like student loan debt, which is probably the most common type of debt that young people hold and if we're talking about the undergraduate variety, that's typically federal student loans with a relatively low interest rate and relatively low amount all things considered, so think like sub 50K total in that world. And then the graduate school and secondary education variety that's typically privately held and can be a lot, think six figures or multiple six figures if you pursued medicine or I guess those would be the broad buckets that from my anecdotal experience, most of the people that I speak with are dealing with something in one of those categories.

Henah:

Yeah, that tracks. I think you'd said in a previous episode, maybe the teacher's episode that the average student loan debt was like $37,000 maybe, and then I have friends who went to medical school and they all have over half a million dollars in debt. So two big buckets with lots of extremes. Obviously when we're calculating net worth, those kinds of debts are considered a liability on the old balance sheet, but oftentimes going back to the rich people love debt piece, there's a good debt that we kind of praise so how would we talk about that debt?

Katie:

Yeah, debt is a liability on the balance sheet and typically anytime we're thinking about good debt, we're thinking about something that has an offsetting asset and hopefully an appreciating asset because theoretically a car loan also has an asset that's offsetting it, but typically a car is getting less valuable over time as opposed to say your human capital, which is ideally getting more valuable over time if it's the asset offsetting your student loan debt or your house. So the classic example would be the mortgage. You have probably six figures in debt, multiple six figures in debt, but you also have an asset that's theoretically worth a commensurate amount so that the net effect of that debt on your balance sheet is either zero or positive. You have more equity than you do debt. If you think through student loan debt in that same way, then you think about yourself as the offsetting asset, which is why then something like credit card debt is considered problematic because there's not typically an offsetting asset and it tends to grow very quickly.

I think about good debt and bad debt, the additional layer or framework that we have to add is the interest rate. How quickly is it growing? And to me anything that's higher than around six or 7% is probably going to edge its way up on the priority list. And then debt that has a lower interest rate than six or 7% is probably going to be less of a priority compared to something like investing just because we're looking at the spread between what can you get in an investment account for that money versus what amount of interest are you going to save by putting that money toward principal.

Henah:

I see, so you're saying six or 7% feels like the historical rate of return inflation adjusted, so that's how you're deciding that number.

Katie:

Exactly.

Henah:

Let's dig deeper into each of these and maybe how we would address it. So credit card debt, like we said, is probably the most common and probably the most urgent given that we've usually seen high interest rates starting at 18 to 22% even on the low end if you have excellent credit. So would you agree that this is your highest financial priority for most and how would we recommend someone approach it, especially if they have a sizable balance?

Katie:

Yes, I think it'd be the highest financial priority beyond the emergency fund perhaps, if the emergency fund is not fully stocked because of how quickly it compounds, but that's a debate I think in the personal finance world is which one should you focus on first because not having an emergency fund and just focusing on credit card debt can sometimes get you back into the same bad spot because if you have an emergency, it's like, well, you got to put it on the credit card because you don't have any savings. So I think that yes, it would be my top priority though within these bounds or the types of debt we're talking about. And I think when you're addressing something like credit card debt, it seems to me that one of the first and most important steps is what is the why behind the debt?

Do you have a pattern of overspending with a core cause that has not yet been addressed? Because if that's the case, then it's more than just we need to come up with some great tactics and strategies to get rid of this particular lump of debt and more about how do we make sure we don't get into this position again? Or is it the result of a truly bizarre one-off emergency, like your dog needed surgery and you could not afford it, or you had a one-off medical emergency that you put on a... Was it something where the credit card debt came from one specific event that is truly rare and you just for whatever reason did not have the money at the time? Or is it like, oh, but I really needed that restoration hardware cloud sectional and I couldn't afford it, so I put it on a credit card. That is not an emergency obviously.

Henah:

I mean speak for yourself. I got the dupe.

Katie:

So we can talk about strategies to pay it down aggressively, but it's important to address the underlying behavior that created it in the first place just to make sure that you don't work really hard to pay it all off and then find yourself in the exact same position six months later. Are you someone with a lot of income who can just buckle down and knock it out by cutting out your discretionary spending? I hear people all the time who earn six figures who just for whatever reason have 10K of credit card debt just sitting there and they don't really feel a sense of urgency about paying it off despite the fact that they could take three months and knock it out immediately.

Henah:

Why do you think that is? I actually don't hear a lot of people like that.

Katie:

It surprises me the amount that when I'll ask people about their numbers and they're like, "Oh, I have 7K in credit card debt," and I'm like, "You've got 50K in savings, just pay off the credit card debt." If I had to guess, I think it's probably the lack of urgency comes from not truly understanding how fast that debt is mushrooming and how much 21% really costs you and the pain of parting with a big lump sum of money because you don't maybe understand just how fast that debt is growing.

Or maybe you're using the credit card still so you're carrying a balance, but because you're still spending money on that credit card, you're not understanding potentially or aware really of what portion of that balance is just your regular spending that would be due anyway and what is leftover from spending you did six months ago, because once you get into the habit of not paying it off fully, it can become confusing to assess what amount of that debt is accruing interest and what you are paying down on time. So I think when in doubt if you fit the bill, pay off the entire card, get it to zero and just have the clean slate if you can.

Henah:

Yeah, so that makes sense. So let's say that you have this 10K debt on a card that's accruing, I don't know, let's say 24.99 interest every month. So what would you recommend whether you're someone who has access to the cash or someone who needs a bit of a runway first to start saving for that pay down?

Katie:

Yeah, if you have the cash and it wouldn't completely deplete your emergency fund to just pay it off, I'd probably go ahead and prioritize paying it off. If you don't have the cash just sitting around and it's more so the situation where it's maybe been mushrooming for a while and you're going to have to make a little bit more extensive of a plan, there are a couple different options that we can probably talk through. I would say the first and foremost one that is not as well known as it probably should be for how relevant it is, is the balance transfer. So a balance transfer, you pay a 3% fee on the entire amount, but you transfer it to a card that has a 0% interest rate for a set period of time.

Henah:

Yeah, I've helped a couple people with that before and I think it's interesting. Sometimes they get very jarred by the 3% fee when they see the number because 3% could be like $300 or $400 of their total balance, and then they're like, "Well, I don't want to take on more just to move it." And I said, "Well, do you understand that what you're accruing in interest is far more than that 3%?" I generally recommend a balance transfer option. Do you have one, like a card specifically that you recommend?

Katie:

Well, I was looking into it and the Discover card, the Discover it Balance Transfer card.

Henah:

She's a Discover girly, I swear.

Katie:

It's 18 months of 0% interest right now so you get a year and a half to aggressively attack it. The con I would say with the balance transfer approach, whether you use that card or another one, because I think typically you'll see 0% for 12 months and it's a little harder to find the 18 month offers, but you do need a good credit score to do this. You need a 690 or above typically to get approved for this, and you may not be approved for the full amount depending on how much debt you have. So they may only approve you to transfer a portion of your total debt to this 0% interest card. But I think of it as it's a good move to stop the interest from continuing to compound. If you have a plan to knock out the debt in that period with 0% interest that you're really serious about and you're using it as a means of just supercharging the progress you would already be making. What you don't want to do is treat this like a band-aid solution that's just going to kick the can down the road.

Henah:

So keeping it and not paying anything off of it.

Katie:

Yeah, if you're just going to transfer it and then let it sit there for another year, you're just going to find yourself in the exact same position when that 0% offer expires. So it's like you have to use that as part of a bigger strategy in order for it to be effective and worth your time and worth paying that 3% fee.

Henah:

So if you're someone who lets say cannot get the card or doesn't have the credit to get approved for any card at this point in time, is there another option perhaps?

Katie:

Well, there are. I would say though the options get progressively worse as we go down the list. So for example, if you're in a really, really bad position and you're at the end of your rope, like last resort, there are 401(k) loans where you can borrow money from your own 401(k) or equivalent account and then you can pay interest to yourself as you pay it back. So people will take out a loan from their 401(k) and they'll pay off the credit cards in full and then you'll be paying yourself back with interest into the 401(k). And employer rules do vary so it's going to vary by plan, but typically they let users borrow up to half of their retirement account balance or $50,000, whichever is less.

So if you have like $200,000 in an account, it'll let you go up to 50K for a maximum of five years. But like I said, this is a last resort move. There is a lot, a lot, a lot of risk associated with this. I would say chiefly, if you lose your job, you have to pay all of that back at once. That loan becomes due right away, which is obviously you're going to find yourself in a very precarious spot like scrambling to pay it back and you're losing out on the investment growth. So there's an opportunity cost associated with you're taking money out of the market and then slowly putting it back in, but you're kind of getting dinged in two places.

So I do think of it like a last resort option and what's probably the best and least tacticy way is making the debt pay down plan using one of those credit card debt calculators online to figure out how much can I afford to throw at this every month and will an extra a hundred dollars a month, $200 a month, how much will that shorten my timeline? And just the good old-fashioned approach of I've spent money in the past that I didn't have, and so now future me has to pay that back. What can I afford to put toward that and where can I shift funds around? So I would say I'd probably try the boring way before I start looking into taking out debt to pay for other debt. That's when things can get a little bit tricky.

Henah:

Yes. So if we say that the zero transfer card is kind of the easiest option and the 401(k) style loan is probably the last resort, what about things like a personal loan or line of credit or a HELOC? I've heard of people doing this so that they don't jeopardize their 401(k)s and also have access to a lower interest rate, but are there any red flags there we need to know about?

Katie:

I would say that probably depends on the rate you can get and the nature of the loan. So for example, personal line of credit with a much lower interest rate. If that does create that interest rate spread for you where you can take advantage of the fact that you only owe 8% instead of 25 and it's a fixed rate of 8%, then okay, sure. I would treat that kind of in the same way that I do a balance transfer card of if you're using that in tandem with a broader plan, that's awesome, being strategic about it but should not be considered a bandaid.

You have to institute it as part of a plan in order for it to be a quote unquote, "good idea". But I think I'd be a little more wary of anything with a floating interest rate. I know many HELOCs have a variable interest rate, so it's not set in stone. It can change when you're borrowing against the equity you have in your home. So I would be wary of that probably just because anytime you're taking out debt to pay back debt. Obviously the credit card interest rate is variable as well, but you want to be careful that you're not just swapping out one floating rate for another.

Henah:

Yeah, that's fair. With some concerted effort, you're saying credit card debt can become more manageable just with a strategy in place. So maybe let's move on to debts of the student loan variety, our favorite. These usually have much higher balances, but I would say probably lower interest rates. So what would be your approach there given that we're trying to tackle the higher interest rate debt first?

Katie:

Yeah, I hear that dilemma quite a bit in our community, which is I have student loan debt and I also want to be saving and investing for the future, which should I be doing more of? Which should I really be focusing on? And I think given the fact that most of the time things like undergraduate loans will have lower than 6% interest rates, I would probably lean toward paying it off quote unquote, "on time," and putting any additional funds into something that can compound for the future and can grow your wealth, especially if you're very young because you have so much time for it to compound so it's going to really go a long way. If the rate is higher, then I would probably prioritize that a little more aggressively, but I think it's important to highlight that this isn't a one or the other decision. You can split your monthly savings between investing in debt pay down if you feel strongly that both are important to you because both are activities that are going to increase your net worth.

One is going to build your assets, the other is going to shrink your liabilities and remember that you incurred this debt through the process of gaining an education that's increasing your earning potential. So ideally you are now earning the type of income that is or will become proportional to the debt. That's maybe easier said than done, but I think your friends that have half a million dollars in medical school debt, hopefully by the time they're attending medical professionals, they'll be earning the type of income where they can pay it down in five or 10 years or whatever their debt pay down timeline is.

Henah:

Right. I have some feelings about student loan debt. I think some of it is kind of predatory, so I'm not saying for them that it's easy or that it will be easy, but I do think that they are will have an upper hand later. I actually have told my husband, maybe invest some of the money versus your student loans beyond the minimum payment because there's also a lot of legislation trying to change or executive orders trying to change student debt. So you may be paying for a thing that could just disappear. The biggest maybe last bucket here is mortgage debts. So is there anything that we'd want to add in that vein? As someone who does not have a mortgage so I do not know.

Katie:

I think my general interest rate rule applies here, which is I can't remember what percentage of Americans that have a mortgage have a sub 4% rate, but I think it's the majority of them.

Henah:

God, I'm jealous.

Katie:

Yeah. So I would say I would be keeping that debt personally for as long as humanly possible. I would not be in any rush to get rid of my 4% interest rate, though there are little things at the margins you can do. So some people like to do that biweekly payments thing, so they'll make rather than one payment a month, they'll split it in half and do half of it every two weeks. That way really you're just making it so that by the end of the year you've done 13 payments instead of 12 because there are 26 weekly chunks in a year, you'll have an extra principal payment every year.

It is a nice hack if you are trying to find ways at the margins to just pay it down a little bit faster. And I know some people feel really strongly about having a paid off house, so some people are going to throw money at it no matter what I say or what rate they have. But I do think that in the interest rate environment we're in, a 3% interest rate is gold. So I would not be rushing that if it were me.

Henah:

Yeah, we have a couple friends who locked it in at that rate and I cry when I think about them. We had an interesting note that came in from a listener named Hillary that I really wanted to address because I think it speaks to maybe the old mission statement of Money with Katie used to say investing for happiness was part of it, which we still care a lot about, but this question really spoke to that. She said, I'm in a full-time master's program and we'll have over a hundred thousand dollars in debt when I graduate.

I've managed to work very part-time during my program, less than $500 per month, and I don't know what to do with the money. Save it to put towards loans that already feel crushing, invest it to help minimally offset this time spent not working full-time, blow it on manicures and the takeout that will make me feel human between studying. Help. I'll be in the market for a six figure job once I graduate, but I'm already stressed. So I totally empathize with this back from my grad school days and I know what I would've recommended, but what say you, Katie?

Katie:

I think in this case my point of view is actually probably going to skew more toward the human approach.

Henah:

I knew it.

Katie:

Because $500 isn't nothing, but in the grand scheme of things, if you're going to come out of school and immediately start making six figures, $500 a month is also not life-changing money so I'd almost be asking where is the ROI, whether that's monetary or psychological going to be the highest, and if spending some of it on takeout and massages is going to make the time easier and more enjoyable or net better educational outcomes, I think that that's valuable. Simultaneously, if we're thinking psychologically, investing some of it might also help defray some of the stress that Hillary is feeling-

Henah:

That's true.

Katie:

... because you'll see yourself making progress toward other goals so I almost am tempted to say a half and half scenario where maybe a Roth IRA would be the perfect candidate here since Hillary's tax burden would be so low. I don't think she'd even pay any income tax on any of this money. I guess she'd still pay FICA, but federal and state, she should be below standard deductions by quite a bit. So like-

Henah:

That's six grand for the year maybe.

Katie:

Yeah. So I'm thinking it's a good opportunity to contribute some of it to a Roth IRA, get some tax-free forever growth off of it, and then maybe allocate the other portion to fun things that are going to make her time in grad school a little bit more enjoyable. I also think if you know you're going to be making a lot of money post grad, it can be helpful to sketch out that budget to see how your monthly payments will fit into it. And just sometimes by planning and envisioning the debt pay down can also help lessen the stress than when you're just looking at that overall amount going, "Oh my god, it's so much money. How am I ever going to pay it off?"

Henah:

I'm thinking of your money mapping exercise. You could make one for today and then make one for the future and see how you'd have to shift things. I really like that last idea.

Katie:

Yeah, I think that that might be nice. I think sometimes awareness just goes a really long way. We're afraid the answer is going to be bad, so we don't want to look, but anytime we can break those big, big numbers down into smaller, more achievable, it's kind of like when we were talking about the 3.3 million for your retirement Henah, and you were like, "Wait, I'm already investing enough to get there in 25 years." And we were like, "Okay, cool, but $3 million sounds so lofty," and so I think sometimes that can help a little bit psychologically.

Henah:

That makes a lot of sense.

Katie:

Well, that is all for this week's Rich Girl Roundup about debt, and we will see you on Wednesday to hear if my traditional versus Roth strategy survived the professional pressure cooker with a licensed professional.

Henah:

Bye.