These lessons aren’t taught in college. 📖 Right now, you’re in a position where you’ve got student loan debts, credit card debts from the semester when you decided to reward yourself with something. The choice of what kind of debt to pay first matters a lot because you can make a mistake that will cost you dearly.
The main issue with financial advice that is offered everywhere is that it considers you as an adult who has mortgage, retirement accounts, and is paying off his credit cards. This isn’t true since you are 21 years old, use meal plan, and intend to start an online business.
The first rule of thumb that you need to follow is to always pay minimum monthly payments on all of your debts. Not paying the minimum on monthly payments ruins your credit score fast like negative Yelp review ruins the local business.
Once you’ve paid the minimums on all your debts, you’ll have an option to pay off some debt with the remaining money. There are two ways to do that – avalanche and snowball approaches. Both of them work but there’s one which is mathematically better than the other and this is what I’m going to prove.
According to avalanche approach, you should apply all your extra money to repay the debt with the highest interest rate. From mathematical point of view, such method allows you to save the most money. If your credit card interest rate is 22% and federal student loan rate is 5%, credit card wins again and again.
The snowball approach claims that you should pay off your debt with the smallest balance. Dave Ramsey is the most well-known proponent of this approach. Of course, it is motivational to repay a whole debt at once. In my opinion, it is less efficient way.
My suggestion to you is to use the avalanche approach if you can control yourself. 🧊 Let’s say you’ve got $300 debt on credit card with 22% interest rate. Repaying it before taking care of other debt is a good decision. The high interest rate eats away your bank account every night.
However, you’re planning to open a business. Starting a business requires investments. Perhaps, you need inventory for your Etsy shop or subscription for Squarespace or supplies for your side business. All that requires money.
My opinion is quite obvious here. Do not borrow any money for your business while you’ve still got high interest rate debts. It is like trying to fill the bath that is leaking at the same time. High interest rates devour whatever profits you’ve earned.
Instead, you should repay all debts with interest rates above 10%. It includes credit card debts, Best Buy store financing, Klarna debts after your online shopping experience. Repay all that before making any investments into your business idea. 🎯
Student loans should be treated separately. They have low interest rates and flexible conditions. You should consider income-driven repayment plans designed just for your situation. You can pay minimum payments on student loans while running your business idea.
Let me give you the strategy to follow. 📋
First, create the list of all your debts with their balances and interest rates. You can use any tool for that – Google Sheets or free Mint application.
Second, set up automatic minimum payments on all debts. This should be an automatic monthly payment from your bank account to ensure that you won’t miss any payment.
Third, allocate all your extra funds to repay the debt with the highest interest rate first. Then proceed with the next highest interest rate debt. Repeat until high interest rate debts will disappear.
Fourth, put your student loans to the backfire and pay minimum payments on them, while you’re funding your business idea. This is where patience pays off.
But there’s one thing you should understand. There are people who recommend you to start your business with debts saying “this is how entrepreneurs do it”. This people are either very lucky or they are selling you some courses. 😅 Successful small businesses have been started on the basis of personal funds and early profits, not borrowed money.
Let me illustrate this point. Sara Blakely has started her Spanx company with her savings, not borrowed money. She repaid her personal debts first and then opened her business with her own money.
One more thing that nobody tells you about business debts. Small business loans and lines of credits are much easier to get if your personal credit rating is good. Lenders look at your personal credit rating while offering business credit. Balance on your credit card will prevent you from obtaining line of credit in the future.
The order of priorities looks as follows.
High interest loans are the first you should repay. These are your emergencies. 🔥
Medical debts and “buy-now-pay-later” debts are second. They have moderate interest rates or can be negotiated if you call them and explain your situation.
Student loans are third. They have low interest rates and are most flexible.
And one more thing that prevents many students from repaying their debts. Credit card companies like Chase and Citi offer balance transfer cards allowing you to repay the debt with 0% APR during 12-18 months. However, you should have the plan to repay the debt before interest rate period will expire, otherwise the rate will become 20% and even higher.
So, starting the business and repaying the debt is a hard challenge to overcome. But it is possible if you are strategic about your order of priorities. Start with eliminating expensive debts, put your student loans on autopay and then invest money in your business idea.
You’ve entered the debt like many other students. You’ll get out of debt like smart students do. With a plan.