A beginner’s guide to smart finances

You asked us questions about student loans, debt, investing and budgeting on our Facebook page. We answer.

Photo: Steven Depolo

Q: Should I pay down my debt or put that money into savings? Does it matter what debt I pay off first?

It depends what kind of debt you’re talking about and how much interest is being accumulated. Some loans, like the best kind of student loans, have lower interest rates, and having debt on something like a mortgage can actually have tax advantages.

If you have multiple types of debt, experts suggest it’s best to pay off the debt that has the highest interest rate (like your credit cards).

There are different types of student loan debt. Some loans come from the federal government, called Stafford or Perkins loans. Those have lower interest rates and more favorable repayment plans. But those federal loans have a cap, and some people need to take out more private loans to fund their education. Private loans have higher interest rates, so chipping away at that debt would be a priority for borrowers.

Some good news, there appear to be benefits to having a long repayment plan on your “good” debt, such as federally-subsidized, low-interest student loans, or loans on your mortgage. First off, you get tax breaks on both of those. Our tax structure is set up in a way that rewards homeowners, and you can usually deduct all the interest on your mortgage. The interest you pay on your student loans is also tax deductible.

Additionally, over time money usually becomes inflated, meaning that the value of the future dollars will be worth less than they are today. So if you’re paying off loans in 10 years, your money is actually going farther.

The advantage to paying off your debt quickly – if you can – is that you won’t have to pay all that interest, and you will likely have better peace of mind knowing you’re not under anyone’s thumb financially.

For more info on the pros and cons of paying off loans early, go here.

If you want to know more about tax breaks involved in home ownership, read this.

Check out this debt website if you want to know about paying back student loans.

Q: What programs for loan forgiveness are out there?

There appear to be pretty limited options for student loan forgiveness, particularly for private loans (for those it basically takes a court order and usually involves permanent disability or death).

But if you go into a job in public service, like education, law enforcement, health, public law or veterinary medicine, you can get your public loans forgiven after 10 years of on-time payments.

The other federal student loan forgiveness program requires 20 or 25 years of on-time repayment (depending on what type of repayment plan you were on). You can be working in any field or job to qualify.

Find out more about loan forgiveness here.

Q: Should I consolidate my student loans? Or should I keep them separate?

Experts say there are pros and cons to consolidating student loans.

The major benefit is ease. Instead of owing different things to different institutions with different interest rates, you just pay once per month to one institution with one fixed interest rate.

With consolidated loans you can also extend the period of time to pay back the loan, significantly lowering your monthly payment.

The disadvantages are that you don’t get the typical six month grace period before you start paying your loans, and you might lose out on some individual benefits of certain loans. For example, police, teachers and firefighters get some cancellation benefits when they meet certain requirements. That would go away.

More information can be found here.

Q: What’s the best way to pay down your student loan debt if you have a job?

It depends on your job, and your income.

The standard repayment plan is a fixed rate every month over 10 years. But if that amount makes up too much of your checkbook, there are other options. You can spread your loans to 20 or 25 years, which brings down your monthly payment, but also adds a lot more interest.

You can also opt for an income-based repayment plan where you cap your payments at a reasonable percentage of your paycheck.

Some people chose a graduated plan where they start with lower payments, and eventually pay more once they have a better job and are earning more.

For a more thorough explanation of these options, click here.

Q: How do we go about building a solid credit score so that within the next 4, 8, 10 years we can buy that house, car and other items that we always dreamed of?

Photo: Sean MacEntee

To build a solid credit score you need to understand what factors influence it. The most widely-used scoring model is the FICO score. It is calculated based on a variety of factors:

  • Payment history (pay on time!)
  • Your credit utilization (make sure to keep low debt balances)
  • The length of your credit history (you’re more creditworthy if you have been building your credit score for years)
  • The types of credit you use (diversify your credit accounts from cash reward to mortgage)
  • New credit (don’t apply for multiple credit accounts in a short period)

If you pay attention to these different factors you should see your credit score building up from nothing to the 700–800s. It may take time, but perhaps then you can get that car or house you’ve always dreamed of.

More details on this at NerdWallet.

Q: How should I invest my money?

Most people are either “passive” or “active” investors, according to investment website the Fool.

A passive investor lets a third-party do most of the trading. They put their money into various funds or indexes, choosing how much risk they’re willing to take. Depending on your goals (Are you saving for retirement? Or to buy a house?) you can assess if you want to place some money in a fund that you see as more long-term and safe versus something shorter-term and more volatile.

An active investor will drill down a bit more and buy, sell and trade options for specific products and companies. It takes a lot more research and work, but it can pay off.

To get in on the market, you must work through a person licensed to trade in securities, but there are ways to do this, including online brokers. That means you sign up for an account, put some money in and choose to buy indexes or stocks (each one usually has a transaction fee). Popular spots are TD Ameritrade, Fidelity Investments and ETRADE.

Hiring a financial advisor or broker means more help and advice. They get to know you, your history, your goals, and your financial situation, and can help you with estate planning, retirement and any other financial advice. Of course, you have to pay for that help.

Read more at Investopedia and the Fool.

Q: What are the do’s and don’ts of having your first job when it comes to budgeting your finances?

Experts advise that the first thing to do is understand how your money flows in and out of your account(s). How much are you bringing in? How much is going out? There are lots of great tools to help with this. Mint is popular, but there are others. Remember that this monthly budget flow is different from your long term assets and goals, although one directly feeds into the other over time. Setting multiple goals and prioritizing those goals is important.

It’s often advised not to spend more than 30-35 percent of your income on housing costs, but depending on your starting salary and where you live (New York, San Francisco) this might be unrealistic. Experts say transportation should be anywhere from 5-15 percent, food is 10-15 percent, loan repayment is ideally 7-15 percent, care/clothing is 10-15 percent, health care is 10-15 percent, and utilities are 5-7 percent. Hopefully this leaves some room for entertainment and savings.

Note that if you add up the highest percentages in each category, you end up with 117 percent. Which simply means that budgets are flexible. Don’t worry if you need to adjust. You should work within each of these ranges to figure out which is the comfortable point for you. If you go over in some, and under in others, that’s OK. It’s your choice.

Experts say an ideal scenario is to begin saving up to 10 percent of your salary for a rainy day (or future major purchases).

Find out more about budgeting here.

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