The Basics Series Part 4 of 5
Achieving financial independence (FI) as a teacher requires finding ways to earn more, save more, and invest more. The amount of time it takes to reach FI is dependent on how aggressively you take action in these three areas.
One thing that is guaranteed to slow you down though is debt. Debt is the ball and chain to those teachers on the path to FI. Debt payments reduce the amount of money you are able to save and invest, which ultimately lengthens your timeline to reaching FI.
This article will focus on understanding debt, the impact of debt on reaching your financial goals and the two most popular strategies for paying off debt.
Let’s jump in.
What is Debt?
Simply put, debt is money that is owed by an individual.
Individuals obtain debt when they borrow money to fund expenses that they currently cannot afford.
In economics, debt is referred to as a liability to the borrower and an asset to the lender.
If not approached the right way, debt can create long term financial and emotional strain on the borrower.
Types of Debt
Debt falls into two categories: Secured Debt and Unsecured Debt.
Secured Debt
Secured debt is any debt that is backed up by an asset acting as collateral.
The two most common types of secured debt are mortgages and car loans.
If you fail to make payments on secured debt, then you risk the lender taking the asset back.
Unsecured Debt
Unsecured debt is debt that does not have collateral protection.
The lender provides funds to the borrower based on creditworthiness alone.
The two most common types of unsecured debt are credit card debt and student loan debt.
If you fail to make payments on unsecured debt then you risk being harassed by debt collectors or having your wages garnished.
Interest Rates
All types of debt, secured or unsecured, are the same in that money is owed to a person or entity.
All types of debt are different based on interest rate.
An interest rate is the cost of borrowing money, expressed as a percentage of the money borrowed.
Basically, the higher the interest rate, the more expensive it is to borrow that money before it’s paid back in full.
Generally, mortgages have low interest rates, student loans and car loans have medium sized interest rates, and credit cards have high interest rates.
Good Debt vs. Bad Debt
Don’t be confused by this title.
Having to payback debt makes achieving Financial Independence more difficult.
It reduces the amount you can save and invest, and that directly impacts your timeline to FI.
Now with that being said, there is no denying that some debts are necessary to achieving where you want to go in life.
For example
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- Mortgage on your house or rental property
- Student loans for college
- Small business loan
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These debts are important and in most cases unavoidable (unless you have hundreds of thousands to put down up front).
If approached the right way though, these debts don’t have to be all bad.
In fact these unavoidable debts can have some redeeming qualities if they increase your future financial situation.
This section explores the difference between good debt and bad debt.
Good Debt
If you view debt as an investment, good debt has low interest and earns you more money in the future.
It’s an asset/endeavor you make payments to that appreciates over time.
Examples of good debt include:
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- Mortgage on your house or rental property
- Student loans for college
- Small business loan
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Although you have to pay these debts off, they have a high likelihood of appreciation.
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- Mortgage debt allows you to buy a house that goes up in value over time.
- Student loan debt results in a job that allows you to earn more.
- Small business loan helps you get your business rolling-leading to profits and income.
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The important distinction is that each of these debts help to increase your future earnings.
Now it’s important to note that good debt is still debt and can quickly turn bad if not approached the right way.
For example, obtaining 100k of student loan debt at 7% annual interest for a teaching job that pays 35k starting is not advisable.
This student loan debt will take you a long time to pay off, and the interest rate is not low enough to justify a long term debt balance.
Basically just be smart, and do the calculations before taking on good debt.
Bad Debt
Staying with the investment analogy, bad debt would be anything that does not earn you more money in the future.
In fact, it does the opposite. Bad debt hurts your future financial situation.
Examples of bad debt include
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- credit card debt
- car loan debt
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Cars, especially new cars, depreciate in value as soon as you drive them off the lot.You are paying off something that loses money each day you drive it. If you need a car, buy a used car and pay upfront if you can.
Credit cards allow consumers to buy things they presently can’t afford-but at a price. Credit cards have very high interest rates and carrying a balance from month to month can be very costly. Unless you are positive that you can pay your balance in full each month, credit cards should be avoided. The consistent use of credit cards demonstrates high spending habits, which ultimately lengthens your time toward reaching Financial Independence.
Of course there are other types of bad debt out there, but these are the most common.
To summarize, bad debt puts restrictions on your future self.
It’s you choosing to have more now but less later.
There is no future gain associated with bad debt, only future loss.
Debt Repayment
The goal of debt repayment should always be to pay off all debt as quickly as possible.
Paying just the minimum payments on debt is not a smart approach.
Paying the minimum each month will lead to greater interest payments and a longer timeline until you’re debt free.
Yea it stinks to put more of your hard earned money to debt payments each month, but you are guaranteed to benefit from it in the future. Just trust me on this one.
Now with that out of the way, to accomplish debt repayment, there are a variety of different strategies and methods available to you.
Some are slightly more cost effective than others but they all generally take the same amount of time to reach zero debt.
The important thing to note when picking your debt repayment method is that there is no one correct option. You need to find the method that works best for you.
Remember, the goal is to pay off all debt as quickly as you can. Period. Whatever method that you choose to get you there is up to you.
The two most common debt repayment methods are the debt snowball and debt avalanche.
Debt Snowball
The basic approach to this method is the following:
1. List all debts (credit card, student loan, car loan, etc..) from smallest amount owed to largest amount owed. Some choose to not include mortgage debt in this list, that choice is up to you.
2. Pay one debt at a time, starting with the smallest value and working your way up to the largest value. Pay as much as you can toward that smallest debt, while only paying the minimum payment toward all other debts.
3. After you pay the smallest debt off, add the payments you were just making to the next smallest debt. This creates a “snowball” effect as you are combining payments from the debt you just paid off to the minimum payments on the next debt you start paying.
4. Continue the process until the largest debt is paid off.
The debt snowball method is effective at providing psychological “win’s” since you are closing out debt accounts early on in the debt repayment process. The goal is to feel these win’s early on, thus motivating you to continue or even accelerate your debt repayment.
The downside of this method is that it is not the most efficient from a math perspective. Strictly looking at the numbers, it would make more since to pay off the debts with the highest interest rates first, regardless of the value of each debt account. Paying off the debts with high interest first saves you money.
Debt Avalanche
The basic approach to this method is the following:
1. List all debts(credit card, student loan, car loan, etc..) from highest interest rate to lowest interest rate. Disregard the total amount owed for each individual debt. Some choose to not include mortgage debt in this list, that choice is up to you.
2. Pay one debt at a time, starting with the highest interest debt and working your way down to the lowest interest debt. Pay as much as you can toward the highest interest debt, while only paying the minimum payment toward all other debts.
3. After you pay the highest interest debt off, add the payments you were just making to the next highest interest debt. The payment amount will continue to increase as payments are combined with the minimum payments being made on the next highest interest debt.
4. Continue the process until the smallest interest debt is paid off.
The debt avalanche method is the most efficient in regard to saving money. Paying off high interest debt first will ultimately save you more money than any other repayment method.
The downside of this method is it can take a long amount of time to pay off your first high interest debt. For some individuals, this may be discouraging, thus increasing the risk that they will not continue with their debt repayment plan.
Student Loan Forgiveness
Before paying off student loan debt, check your eligibility for student loan forgiveness programs.
Teachers have access to a variety of different federal and state sponsored student loan forgiveness programs aimed at reducing or eliminating your student loan debt.
Below is a list of the most notable programs, including key aspects of each program and links for further information.
Public Service Loan Forgiveness (PSLF)
Forgives the remaining balance on your Federal Direct Loans after 120 qualifying payments
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- Broad Eligibility Requirements
- Don’t have to teach at a low income school
- Greatest benefit for those with high loan balances
- 10 years (120 payments) before eligible for forgiveness
- Must have Direct Loans
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For specific qualification requirements and further information click here.
Teacher Loan Forgiveness (TLF)
Forgives up to $17,500 of your Direct or FFEL Subsidized or Unsubsidized Loans after 5 complete and consecutive years of teaching at a qualifying school.
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- More specific eligibility requirements
- Must have worked in a qualifying school for 5 complete and consecutive years
- PLUS loans and Perkins loans are not eligible
- Amount forgiven is determined by subject area/grade level
- Can apply after the five year teaching requirement
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For specific qualification requirements and further information click here.
Perkins Loan Cancellation
Forgives up to 100% of your Federal Perkins Loan Program if you teach full-time at a low-income school, or if you teach certain subjects.
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- Only forgives Federal Perkins Loans
- Must teach at a low income school or teach certain subjects
- Full Forgiveness takes 5 years
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- 15% cancelled in year 1 and 2
- 20% cancelled in year 3 and 4
- 30% cancelled in year 5
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For specific qualification requirements and further information click here.
State Sponsored Programs
Many states offer loan forgiveness programs for teachers, especially those that teach in high need areas.
For specific information about the student loan forgiveness programs in your state click here.
The Bottom Line
All debt, good or bad, restricts the amount of money you are able to save and invest.
Having debt payments extends your timeline for reaching Financial Independence.
Pay off debt as quickly as you can so that more of your earnings can go to saving and investing.
What’s Next?
Continue on to Part 5 of 5 in the Basics Series – Investing: The Basics for Teachers.
