“We Need to Talk about Debt”

If talking about money is taboo, then discussing debt is even trickier. Even more personal.

Debt has been “normalised” in our culture. Just like over-spending. Two sides of the same digital coin.

Defining Debt

Debt can be divided into three categories:

  1. Educational debt (student loans)
  2. Housing debt (mortgages)
  3. Consumer debt (credit cards, store cards, car loans, bank loans, payday loans)

In general, if you’ve gone into debt to get yourself a degree or to buy a house, then those types of debt (educational or housing) are deemed as acceptable or OK in the world of personal finance.

Why? Because, on average, the overall effect of finishing higher education is an asset for the majority of graduates as it gives them (and you) access to higher paying careers.

“All generalisations are false.

Including this one”.

mark twain

Similarly, owning a home – via mortgage payments – is also considered an acceptable debt, because a home is an asset which typically increases in value over the lifetime of the mortgage.

We’ll examine the pros & cons of mortgage debt in the next chapter, but before then we need to make a UK-centric shallow dive into the debt that most young professionals will have – the Student Loan.

The Student Loan Maze

If you already have a Student Loan from an English university then you need to listen to Martin Lewis.

If you’re considering taking out a Student Loan from an English University then you need to listen to Martin Lewis.

Student Loans Defined & Dissected by “The Master”

In either case, that’s the single best piece of advice that Anonymous Dad could ever relay on this subject.

Simply because Martin Lewis is the very best at explaining why:

  • The student loan should be called “a graduate tax” or a “graduate contribution”
  • How the UK government completely obscures the impact of “parental contribution” in the decision-making process
  • Getting a university education is not just about getting a better job after graduation
  • The truly unique characteristics of the Student Loan – in particular the accrued interest

Does that sound a bit daunting? Good, because it is.

Yet, the sooner you fully understand the bureaucratic and political maze that is the Student Loan system – the better off you’ll be.

Psychologically and practically. And perhaps, financially.

Playing The Percentages: The Student Loan

  • It’s estimated only 17% of students will pay back their student loans in full
  • Which means 83% of students won’t pay back their student loan before the 30-year payback period ceases
  • Once a (former) student earns above the minimum threshold, the Student loan company extracts 9% of that gross salary – at source. Before anyone can stop them.
  • Currently, only 6% of that 9% pays reduces the principal (the original amount owed)
  • Therefore, 3% (or more for higher earners) of each month’s gross pay goes back to the government in interest payments

Student Loans: Before & After

Before taking out a Student Loan, it’s worth thinking carefully about your potential future salary. And how likely it may be that you’ll be in full-time employment for a 30 year stretch.

If you’re projecting that you’d be most likely be earning below the national average wage and working intermittently, then it’s likely that the impact of the Student Loan on your personal finances would be minimal.

However, for the target readership of this blog, that scenario is not on your agenda. Instead your ambition would be to earn substantially over the average national wage and to work consistently (if the economy and pandemics allow) for at least 20 years after graduation.

So, for you, dear reader, paying back your Student Loan is a real issue. To paraphrase Martin Lewis, paying it back will be a financial burden, but it shouldn’t be a psychological burden.

Why not a psychological burden?

Well, paying it proves that you’ve been successful in that you and your degree have indeed got you an above-average salary. Overall, it’s a positive transaction.

And, as Martin demonstrates, any hikes in interest rates can often be irrelevant as time runs out before your extra payments come due.

All that said, the financial burden is real.

To Anonymous Dad, that 9% payback is alarmingly close to 10%.

Potentially, the Student Loan could represent a near-as-dammit 10% rake-off of your take-home pay.

Potentially, each and every month for 30 years. So, what’s to be done?

Well, there’s no need to overthink your Student Loan payments. Because HM government isn’t allowing you that opportunity.

Anymore than a McDonalds drive-through gives you an option of when to pay for your cheeseburger.

It’ll take that 9% in the blink of an eye, and the only option it leaves you then is to make overpayments. Overpayments would reduce the amount of time you were indebted to the Student Loan company.

But wait. This is where the advice of the money-saving expert Martin Lewis really comes into its own…

Whereas the “get out of debt fast” instincts of Anonymous Dad might have suggested that you throw any extra funds against your Student Loan, Martin Lewis strongly suggests thinking twice before making that move.

He suggests finding other avenues for using any extra funds you may have by increasing your savings, paying off credit cards or saving for a mortgage deposit. Again, listen or read to what he has to say. Don’t rush into a decision.

My two take-aways from this Student Loan issue are these:

  1. If there’s a good chance that the degree you’re considering will not give you a significant opportunity to easily exceed the national average wage, then seriously consider not going to university. Because you’ll risk paying a “graduate tax” of 9% for decades…
  2. If you have graduated with a Student Loan, then now is a good time to get serious about your career and your earnings.

    Ideally, you should aim to get promoted often enough in your mid-twenties and thirties, not in an attempt to see off any Student Loan…but instead to create enough “financial margin” to reach your personal finance targets – and especially FU Money.

The “Evil Twin” to Your FU Money

Consumer debt is the “evil twin” that can screw with your attempts to get to a place of FU Money.

Consumer debt is any debt that you have incurred that can’t be attributed to buying a house or getting an education or further qualifications.

Unsurprisingly, the list of “things” or “stuff” that comprise a person’s consumer debt is often predictable, occasionally unique and potentially endless.

Regardless of the “profile” of your own consumer debt, the simple fact is that your debt will stop you from:

  • Increasing your Percentage Savings Rate
  • Building your Emergency Fund
  • Starting on the path to FU Money

So, you need to get rid of your debt. By decreasing your spending. Or by increasing your income. And ideally, both.

Debt : THE BOTTLENECK in Personal Finance

It’s very easy to get very emotional about debt very quickly. And that just generates anxiety but not much else.

Instead, Anonymous Dad suggests you look at debt using the “The Theory of Constraints” (TOC) and the associated term “bottleneck”.

Because debt is THE BOTTLENECK that will prevent you from:

a) having any surplus income and

b) using any surplus income for the first two milestones of financial freedom: the Emergency Fund & FU Money

So, let’s look at the “bad news” first – when young professionals are “debt-constrained” it looks a lot like this:

With Debt

Contrast that with the simpler “good news”, the fast flowing liquidity of a debt-free individual:

Without Debt

Here’s a simple video on bottlenecks and the Theory of Constraints. In less than four minutes, the gent from avimarketing does a fine job of explaining what to do with a bottleneck:

Bottlenecks and TOC

Caveat: of course, we don’t want to maximise any debt, we want to exploit, subordinate and elevate the debt bottleneck until it no longer exists.

So, be adaptable and “translate” the terminology used in the video accordingly.

Budgeting: The Basics

The personal finance blogosphere is divided around budgeting.

“There are two types of people in this world. Those who divide people into two types. And those that don’t.”

various

Some authors reckon young adults “can’t budget, won’t budget”.

The remaining authors reckon young adults can budget and, more importantly, should budget.

So, forgetting everyone else, the question remains for you is “Do I need to budget?”

Well, it’s your choice, but I reckon you will need to budget if one or more of the conditions below apply to you:

1. You have no Emergency Fund
2. You live from one pay-day to the next
3. You’re in debt and it’s getting worse
3 Good Reasons to Start A Budget

The good news is that if you’ve already completed the Total Monthly Spend spreadsheet, you’ll already put together your first budget statement. Without realising.

Good budgeting is rarely about -if ever – about micro-managing.

Rather, it’s a calm, objective process of mapping money flows into and out of your accounts. After all, it’s your money, it’s your life.

It’s a cliché, but with regard to your money “clarity is power”.

There’s no competitive advantage for you in ignoring how you typically – and also randomly – spend the money you make each month.

Your budget will show you the landscape of your personal finance. There’ll be three main rivers (or outflows) in that picture. There may be a swamp or two. Eventually, there may be a couple of barns with stores of grain. One day there may be a castle or fortress of solitude that you have built.

The Big Picture actions around personal budgeting are these:

  1. Set up direct debits within your online bank account
  2. Optimise the timing of your direct debits. Schedule the payment of your largest direct debits within 3-5 working days of being paid.
  3. Make direct debits to your own “Saving & Investing Silos”. The Emergency Fund. Your FU Money. This is the essence of “paying yourself first.”
  4. Make direct debits to your main creditors (landlord / mortgage company, credit cards, bank loans etc)

Hint: To keep things simple, just track all of these direct debits in the Total Monthly Spend spreadsheet.

Just put an asterix * against those monthly payments that you’ve automated via a direct debit.

Summary

We’ve briefly looked at the related topics of debt and budgeting.

In particular, that “elephant in the room” that is the Student Loan. Forewarned is forearmed.

And even if these were retrospective lightbulbs going off in your head, the hope is that you can deal with your Student Loan more efficiently.

As usual, “context is everything”.

And you have to put your debt and your spending habits into context too. How much those two aspects are affecting your new ambitions to create an Emergency Fund and FU Money.

Because eventually “the money game” is about practise, not theory. As the tech-author Ben Horwitz states in the title of his most recent book…”what you do is who you are“.

What you do about your debt, your direct debits and your budgeting is what will make the difference. The things you stop doing. The things you start doing.

You could be good today. But instead you choose tomorrow…

marcus aurelius