Saving Money as a Young Adult while Repaying your Debt.

In your early 20s, many young adults get an abrupt wake-up call as they try to make sense of their personal finances. While a steady job opens up doors to affording certain luxuries (e.g. new car, or vacationing aboard), it’s also very easy to acquire new debt.

Credit card companies are quick to issue young professionals credit cards. Often with low or no interest for certain time periods: this makes it easy to maintain balances on these credit cards. Allstate recommends that an average person use 25-32% of their monthly income towards paying off debts: credit cards, student loans, etc. Credit card debt higher than 8% should be aggressively paid first and followed by student debts.

Reducing the debt means paying enough to cover the monthly interest charges and reducing the principle balance. Paying off the balance quicker will lower the total accruing interest costs of the debt.

There are different strategies for people with multiple credit cards having debt on each card. The first strategy is to pay off the card with the highest interest rate first and work at eliminating the balances of the remaining cards one at a time.

Another strategy is to consolidate the debt of the credit cards into one payment with a lower interest rate. If Jane Doe has three credit cards with $2,000 each, Card A has 10% Interest; Card B has 12%; and Card C has 11%. It’s an average of 11%, with a $6,000 total balance: it costs her approximately $660 per month to maintain. Consolidating the credit card debt into one loan with a 6% interest rate, would save her $300 per month in interest. It would cost Jane $360 per month to hold that debt.

Maintaining debt vs. Saving for the future

After settling credit card debt, most people think about setting up an emergency fund or retirement account. Some financial advisors recommend saving for your retirement before paying off your student debt. The National Association of Personal Financial Advisors (NAPFA) suggests the opposite. They prefer young people pay off their student debts as soon as possible. If John Doe contributed $3000 to an IRA CD with 1.25%, he makes $37.50. Compare that to John’s student debt of $10,000 at 1.00% interest, it costs him $100 to maintain that debt. If John uses the $3000 to pay off the student debt, next year a $7,000 balance will cost him $70 to maintain. He saves $30 of interest during year 2 of the loan.

While contributing to a retirement account, NAPFA recommends aggressively putting money into a rainy account until you have 2-5 months of living expenses covered. This helps people avoid charging emergency purchases on high interest credit cards.