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| Uncommon Sense | Good debt vs. bad debt: both are tough in your 20s
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Personal debt comes in many flavors. Sometimes 'sensible' debt, such as student loans, can be harder to dig out of than the frivolous kind -- as our newest Woman in Red, Stephanie, shows.
By MP Dunleavey
Editor's note: Columnist MP Dunleavey and seven other women have come together online to strip away the myths surrounding money, speak frankly about their finances and liberate themselves from debt. Follow the quest for financial fabulousness of these Women in Red every other Monday in Dunleavey's column on MSN Money.
When I first met Stephanie, 27, a newcomer to the Women in Red, I was shocked to hear that she had nearly $30,000 in debt.
In fact, in her initial letter to me, she scoffed at the puny amounts of credit-card debt carried by gals in the group such as Brice and Lyndsey, who have about $6,000 and $12,000, respectively.
But as I quickly learned, Stephanies debt was of a different stripe. And while its tempting to brand all debt as bad, hers didnt start out that way. In fact, many financial experts would call most of what Stephanie owes "good debt," but that doesn't make it any easier to pay off.
The many faces of debt
I dont like to compare the women in the group. Each ones situation is unique. That said, Lyndsey and Stephanie, our two 20-somethings, provide an illuminating contrast about just how different debt can be.
Lyndsey, 26, racked up her $12,000 credit-card debt with some impulse spending and the occasional shopping trip to New York City with her girlfriends. Her parents were able to cover her college costs, so she didnt owe any money there. She has what I like to call "lifestyle debt."
At the other extreme, Stephanie has $13,000 in student loans, a $14,000 car loan and a couple of thousand on plastic, used to buy a sofa and computer after she and her husband got married last year.
Stephanie has a classic case of "just-starting-out debt," which is borrowing to make an investment in your future. Her education debt will help her to earn more money someday; and while Chicago has better-than-average public transit, she and her husband still needed a car. (They could have spent less on a used car, but Stephanie says she plans to drive her Honda Civic until it falls apart.) Even the computer can be viewed as an investment, if it helps her to manage her money better or to work from home. So who's going to quibble over a sofa?
Which hole is deeper?
Ironically, Lyndseys lifestyle debt is going to be a lot easier to pay down. In fact, in just these last few months, she is already making serious progress toward the goals we outlined when she started.
Given that Lyndsey earns $43,000 a year and has relatively low overhead -- her rent is just $650, a screaming deal in the Washington, D.C., area -- we figured that she could at least double her monthly credit-card payments of $300.
And given that shes a bit of an impulse spender, we also decided she could rein in the shopping sprees and eating out to make those fatter payments.
Presto, change-o -- shes doing it! I cant help but be impressed.
| Lyndsey's debt, then and now | | Credit cards | | | Amount owed | $12,000 | | | % Interest rate | 9% | | | Old payment | $300 | | | Months to payoff | 48 | | | | | | New payment | $600 | | | Months to payoff | 22 | | | Interest saved | $1,270 | |
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By cooking more often (that means microwaving, she clarified), shopping at her parents house for staples, steering clear of clothing sales and so on, Lyndsey is now paying $600 a month toward her cards and even starting to save. She can be debt-free in a little less than two years.
Stephanies situation is harder to unwind. She doesn't have a lot of "fat" to cut from her already lean budget the way Lyndsey did. And she can't return her education for a refund, nor can she sell her car and expect to get enough cash to pay off the loan and buy a used vehicle. She's going to have to get creative.
In over her head
While Stephanie earns $37,000 and her husband earns $32,000, the two havent yet combined their finances, so Stephanie is shouldering all the debt payments. That means a $200 student-loan payment and a $300 car payment, plus another $100 (give or take) toward her credit card.
More 'Women in Red' on MSN Money
It was relatively easy for Lyndsey to double her monthly payments. But Stephanie is already paying almost 17% of her gross (and about 30% of her take-home pay) toward her loans.
If youre working with the 60% Solution budget, the goal is to limit your committed expenses to about 60% of your gross income. With her debt payments, Stephanie's spending commitments are close to 80% of her gross, which leaves little room to ramp up those payments and pay down debt more aggressively. In a word, she's overcommitted -- a bind many in her generation know all too well.
Welcome to Generation Debt
Theres justified concern about the load of debt many young people carry into their adult lives. According to Demos, a research group in New York, the amount of credit-card debt alone carried by kids aged 18 to 24 increased by 104% between 1992 and 2001. And young adults ages 25 to 34 have the countrys second-highest bankruptcy rates (after folks 35 to 44).
Worse, a large number seem to be in Stephanies shoes -- with consumer debt and big student loans. Since 1997, the average student-loan debt has increased to $18,900 from $11,400 -- a leap of 66%, according to a national student loan survey by Nellie Mae.
Those paying for part of their education with a credit card increased by 27% in that time, as well.
Making tough choices
Anyone in debt has to make tough choices. When my husband and I finally confronted our combined credit-card debt last year (then $24,000), we had to get downright medieval about it (see "7 ways to radically cut your debt"). As a result, a year later were now only $14,000 in the hole.
Stephanie joined the WIR because she was ready to take action. Here are the choices shes weighing.- Big budget cuts: The first thing new recruits face in WIR Bootcamp is the mandatory spending diary. This is, in part, to see where your money goes -- but also to see what your financial habits are. Im a scrimp/splurge personality, Stephanie reported after tracking her spending for a week. Its like retail bulimia. I tend to obsess about saving and watch every penny -- (and then) I binge shop.
Stephanie says her first step is to cut out the sudden splurges so she can ramp up that $200 student-loan payment, maybe even double it, which would allow her to pay off her student debt completely in 30 months. Once the student loan is paid off, then she can start putting that $400 a month toward her car loan. If she keeps at it, she can be debt-free in a little over three years.
- Borrow from family: The last thing Stephanie wants to do is get her folks involved in her debt mess, but the fact is that taking out a no-interest loan from her parents could save her about $3,500 in student-loan interest. While she doesnt feel ready to ask for such a big favor, she did discuss the problem with them and they gave her $1,200, which brings the loan down to $10,800.
- Think like a team: Because Stephanie and her husband have only been married a year, they are still behaving like two separate financial entities -- and at first Stephanie wanted to keep it that way. But again, extreme debt calls for desperate measures. Stephanie says that she and her husband are now pooling their resources to get out of debt faster. Hes taking on the sofa-computer payments, and may even ask his family for some financial help.
- Earn extra income: Not only is Stephanie looking for a part-time job (even dog-walking or babysitting, she says), but her husband has decided this is as good a time as any to ramp up his own career and get a better-paying job.
| Stephanie's debt, then and now | | Student loan | Car loan | Credit cards | Total | | Amount owed | $13,000 | $14,000 | $2,500 | $29,500 | | % Interest rate | 7.1% | 4.9% | 0% | | | Old payment | $200 | $300 | $100 | $600 | | Months to payoff | 83 | 52 | 25 | 57 | | | | | | | Gift | $1,200 | | | | | New payment | $400 | $300 | $100 | $800 | | Months to payoff | 30 | 38 | 25 | 38 | | Interest saved | $1,978 | $870 | | $2,848 |
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Note: Calculations for total time to payoff and interest savings assume monthly payments for paid-off debts are applied to remaining debt.
Youth has its advantages
All these options take time and require some inconvenience (swallowing pride being a big one), but Stephanies determination is a big plus. Another advantage is that your 20s are a time when raises and promotions come more quickly. If Stephanie and her husband are smart, they wont use those increases to upgrade their lifestyle, but rather will put most of the extra cash toward debt.
Whatever kind of debt you have, good or bad, paying it down takes stamina and the willingness to rearrange what you once believed were your priorities. If Lyndsey and Stephanie keep up their current pace, they will be debt-free much sooner than they thought possible. I wish Id been this aggressive when I was in my 20s -- Id be debt-free now, too.
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