Every once in a while, I like to listen to a little Dave Ramsey. You can say what you want about him, but when it comes to motivating you to pay off your debt, I don’t think anyone can beat him. His secret is just how simple and doable he makes things seem. Listen to him talk and you can’t help but feel that you’ll be able to crush any debt really fast.
Take the typical call he gets from someone asking about how to handle their student loans. It usually goes something like this. Someone calls in talking about how they have some astronomical amount of student loans – $200,000 worth, for example. Maybe this caller will make a decent salary, $100,000 perhaps. Dave will then tell them that with a little grit and determination, they should be able to get out of it in just a few years. Live on $50k per year, throw $50k per year at the loans, and you should be done within four years. $200,000 divided by $50,000 equals four years. It sounds simple enough.
Of course, anyone who’s been in debt repayment mode knows that paying off debt isn’t quite that simple. There’s much more to it than just paying back what you borrowed. I find that when many people get started with paying down their debt, they get frustrated that it seems to be taking longer than it seems like it should. That’s how I felt anyway. I made $110,000 as my starting salary out of law school. It still took me over two years to pay off $87,000 worth of student loans. With that income, it seems like I should have been able to pay it off a lot faster.
But, when it comes to debt, you’ve got two things that are going to slow down your debt repayment journey – interest and taxes. It’s good to understand the impact both of these factors will have on the speed of your debt repayment.
Paying Interest Will Slow Down Your Debt Repayment
It seems pretty obvious, but you’d be surprised at how many people forget or don’t seem to understand that they have to pay interest on top of their debt. The fact is, debt isn’t free. If you borrow money, no matter what, you’re going to have to pay back more than what you borrowed.
Look at my own debt repayment story. My $87,000 worth of student loans required me to spend $102,000 in order to pay it all off. That’s a pretty big number I had to pay back – about 17% more than what I actually borrowed. And that’s with me paying off my debt just a few years out of school.
If you don’t know how interest works, it’s generally pretty simple. Just multiply your debt by your interest rate. That tells you how much interest your debt accrues in a year. If you have $100,000 worth of student loans at a 7% interest rate, you’re looking at $7,000 worth of interest per year. If you really want to see how much your debt costs, try calculating how much interest your debt costs per day. To do that, just divide the total yearly interest by 365. You might be surprised at the number you see.
The key takeaway with all this is that paying off your debt doesn’t just mean paying back everything you borrowed. You’re going to have to pay back more. That’s why your debt will seem to take longer than it should to pay off. Throwing $50k per year at a $200k loan won’t get the job done in four years. Intuitively, we all know this, but for some reason, a lot of us seem to forget it.
Paying Debt Requires Paying With After-Tax Money
The other thing that most people forget about debt – and what I think really makes it a pain to tackle – is that debt has to be paid with after-tax money. If you’re an aggressive saver with your pre-tax retirement savings, you’ll find that you’ll be able to accumulate money pretty fast. It’s not so difficult to build up savings when you’re able to save all of it without having to pay the government first.
The same isn’t true with paying off debt. Writing a $1,000 check doesn’t actually cost you $1,000. You have to remember that you’ve got to pay state and federal taxes, as well as FICA taxes. For a lot of people, you’ll be paying 30% or more of your income in taxes when you add it all together.
Thus, writing a $1,000 check really requires you to earn $1,400 or more in order to have $1,000 to spend. That’s a pretty significant difference that’s going to dramatically slow down your debt killing abilities. Even worse, when you’re in aggressive debt repayment mode, you can’t really do much to reduce your tax liability since you need all of the money you can get your hands on.
What To Do?
Given these two things that are killing your debt repayment ability, what’s someone to do? Here are my thoughts:
Refinance Your Loans. You’ll pay less interest if you refinance your loans down to a lower interest rate. If you’re in a position where you’re making a good salary and plan to pay off your student loans as fast as you can, it makes sense to refinance using a company like SoFi, Commonbond, or Earnest. Tools like LendEdu or Credible are also great ways to find lower interest rates (they pretty much aggregate all of the student loan refinancing companies out there so you can compare interest rates in one spot). I wasted a year paying higher interest rates than I needed to simply because I didn’t know about refinancing my student loans. If I had realized it sooner, I could have saved much more money and paid my debt off faster.
Hustle To Pay Off Your Debt. Paying off your debt is going to be painful, no matter how you slice it. It feels like such a waste to have to spend so much of your hard earned, post-tax cash paying for what essentially amounts to a piece of paper. The key thing to remember is, the sooner you crush that debt, the sooner you’ll be able to devote more of your resources towards other goals. And when you’re debt free, you’ll have so much more freedom to do what you want (trust me, I know).
Your debt is going to be harder than you think to pay off. That’s just a fact given how debt works. You should recognize this and go into your debt repayment with eyes wide open. I’ve said before that paying off debt is never easy. But if you understand the obstacles that are in your way, it should be easier to stay motivated and on track.
It might take you longer to pay off your debt than it seems like it should. If that’s the case, you’ll at least know why. Stay motivated and you’ll eventually get there!
Kevin is an attorney and the blogger behind Financial Panther, a blog about personal finance, travel hacking, and side hustling using the sharing economy. He paid off $87,000 worth of student loans in just 2.5 years by choosing not to live like a big shot lawyer.
Kevin is passionate about earning money using the sharing economy and you can see all the ways he makes extra income every month in his side hustle reports. (If you want a quick side hustle win, check out Job Spotter)
Kevin is also big on using the latest fintech apps to improve his finances. Some of Kevin's favorite fintech apps include:
- Personal Capital. One of best apps to monitor your portfolio and track your net worth. Plus, it's free to use and you get $20 for creating an account.
Feel free to send Kevin a message here.
I’m a big fan of paying off debt early… interest can take such a hit on your finances! And I never thought about the after-tax aspect, but you are right! Here’s to hustling away debt 🙂
It stinks when you’re in debt payoff mode simply because you’re forced to keep your income as high as possible in order to pay off debt quickly. I always think best thing to do is just crush that debt as fast as you can so you can get on with doing what you want to do.
Ugh interest and taxes, you’re telling me. I’m looking at what it’ll take to pay down our mortgage early and the interest is killer. I’m going to throw every dollar of side-hustle money toward it though, plus we’ll plan on paying it off within 20 years (instead of 30) maximum.
It’s easy to get discouraged, but setting up a system to just automatically take care of it – even slowly – will be helpful.
Making it automatic is definitely key. Keep it out of your hands!
“Your debt is going to be harder than you think to pay off.”
No kidding, I’ve been getting discouraged lately at how slow this process is actually taking me. It has been since March since I have been taking my debt serious and it is going to be a slowwww process.
Keep pushing at it though! Once you get through that wall it starts going faster.
FWIW, paying off debt can also be easier or quicker than you think because….1) You may get a promotion, raise and unexpected bonuses over the period of your repayment, allowing you to dedicate increased income to the repayment as long as you avoid lifestyle creep. 2) Mortgage and student loan interest are deductible up to a certain amount. The tax refund from this can go towards paying off more debt. 3) In fact, the majority of tax refunds should go to debt when you’re aggressively paying off debt. Ideally, you’d avoid a tax refund obviously, but lump sum payouts like tax refunds and bonuses make it really easy to take big chunks out of debt without much mental effort or discipline.
When I graduated with my bachelors, my initial loan balance was higher than my starting salary but my salary nearly doubled over the course of the 3.5 years that my debt took to payoff. I also made a rule for myself where 80% of all bonuses and tax refunds would go towards debt, and I allowed myself to spend the rest. So all in all, the outlook was pretty bleak when I initially started to payoff my debt, but it turned out much better than I expected. It taught me the financial discipline and frugality that will now allow me to retire early which almost makes the whole debt ordeal worth it since I learned an invaluable life lesson.
On a personal note, the hardest thing for me when paying off my debt is: the opportunity cost of my capital.
As an optimist – I see investment opportunities everywhere (not always a good thing).
I want to pay off my debt, but my natural inclination to want to outperform the interest rate of my debt – makes paying off my debt harder than it seems.
The opportunity cost thing is a tough one for me to argue against and its the most common thing I hear when people say they don’t want to pay off their debt. It’s tough because in hindsight, we can see we can make more, but who knows what the future holds. If I hadn’t paid off my student loans, I’d be sitting on over $100k in investments right now. But I always see that in hindsight. I really didn’t know what the future would hold.