The Cost of Debt
Debt is often necessary on the path to financial success, but it is probably the most common way that people get off track. Debt costs money, in the form of interest charges. Interest is the opposite of a discount; it is an extra cost associated with each dollar that is borrowed. Therefore, a key step in making good financial decisions about debt is to understand those interest charges/rates, which can vary significantly, depending on the type of debt.
Typical Interest Rates on Loans
|Type of Loan||Typical Interest rate (from May 2018)|
|Credit Card debt||15.0%|
|Unsubsidized Graduate Student Loan||6.5%|
|30-year fixed Home mortgage||4.5%|
|Subsidized Undergraduate Student loan debt||4.0%|
|15-year fixed Home mortgage||3.9%|
Important note: Interest rates change! The above rates are meant to be indicative of the relative rates that are generally available and are for illustrative purposes only.
Key Money Matter Points:
- Pay-off Your Credit Card Balance EVERY Month: The first thing that should jump out from this table is how very expensive credit card debt is relative to the other types of debt. It reached an 18 year high of 15.32% in March 2018, according to the Federal Reserve. If you are carrying a credit card balance every month, the best thing you can do for your financial health is to STOP! Make a plan to pay off your card(s) every month. If you feel like “you just can’t do it”, then start listening to Dave Ramsey’s daily radio broadcasts which have helped thousands of people get out of debt. Many financial advisors (including Dave Ramsey) suggest that you cut up your cards and shift 100% to cash. This may seem extreme, but so is 15% interest!
A 15% interest rate means that everything you buy carries with it an extra 15% “tax”. 15% is more than double what you pay in sales tax on that same item, and that sales tax goes to lots of things you support (like schools, courts, police, parks, etc.), the 15% you pay just goes to the credit card company.
- A Student Loan is an investment; make it a smart one: It is important to recognize that a student loan is only a good financial investment if the increase in salary that will be gained is more than enough to pay for the student loan plus interest. Attending graduate school can be especially costly because student loan debt can increase quickly. Many people are not aware that loans for graduate school generally carry higher interest rates than undergraduate student loans. Additionally, although undergraduate loan repayments can usually be deferred if a student goes to graduate school, the interest on the undergraduate loans is being added to the total loan balance each year. A financial planner can work through the calculations necessary to determine how much in loans your desired career can support.
- Double-check the Tax Deductibility of your Home Mortgage: Of the loan types listed in the table, only home mortgage interest is tax deductible; but be careful, because the deductibility may have changed for you because of the Tax Cut and Jobs Act (TCJA: that was passed in December 2017 and is effective this year). The TCJA raised the standard deduction to $24,000 for a married couple. Therefore, for any mortgage interest to be tax deductible, your total itemized deductions on Form 1040 Schedule A must add up to greater than $24,000.
Assuming a house in Satellite Beach that is currently worth $400,000 and carries a $300,000, 30-year mortgage @ 4.5% interest, the mortgage interest will likely be less than $12,000/year. Then add to that $7,000 in deductible property taxes ($12,000 + $7,000=$19,000), and you are still $5,000 below the new $24,000 standard deduction. Unless you give a large amount to charities, the tax benefit of your mortgage has likely gone away. This means that making extra payments to pay-down your mortgage may make more sense than it did before the passage of the TCJA.
John Krehbiel is an independent, fee-for-advice, financial planner who specializes in helping busy couples and tech professionals in Brevard County, Florida. Krehbiel Financial LLC is a Registered Investment Advisor in the State of Florida and Texas. The information in this article should not be relied upon for the purposes of transacting securities or other investments. You should consult with a financial advisor or other professional to determine what may be best for your individual needs.