It is key for every young person, especially those recently living on their own for the first time, to understand what debt is. Chances are you have had a parental cushion for financial support for all these years and so the reality of what debt is perhaps only just sinking in now that you’re in charge of paying your bills yourself, in addition to your student or even your credit card loans, the balance for the latter especially seeming to move only slightly each month.

We’ll come back to that.

As discussed in this space before, the term “debt” refers to the use of any kind of anticipated income or future earning today to pay for something that you don’t have the cash on hand to pay for at that specific moment in time.

You are now a debtor, and the entity to which you owe money is the creditor. And because there was the signing of a contract as to how and when the loan will be repaid, it means that you are legally bound to repay that debt. You don’t get to walk away in the event that something unforeseen happens; say, you lose your job. This is why you have to carefully consider what you’re taking on when you take on a loan because what you’ve in essence taken on is debt, and debt must be repaid, usually with interest.

Interest rates

If you borrow money from a friend or family member, depending on the amount, they will probably not require interest, just the flat figure you borrowed. However, a loan-lending institution will absolutely require interest; this is, after all, one of the ways it makes money and is able to remain in business. Interest is the price you pay for the privilege of the institution fronting the money and deferring repayment from you until later. The interest rate is the amount a lender charges a borrower and is really a percentage of the principal, which is the total amount of the loan, or the money you originally agree to repay. It is very important to find out what the interest rate is and how it is calculated.

Credit card debt

In the case of credit cards, interest is charged when you carry a balance on your card. Yes, a credit card is a great convenience, but it must be used responsibly. Do not pull it out for purchase on every whim and fancy. The card company will multiply the balance owed each day by a daily interest rate and add that to what you owe. This goes on for every day of every month of every year until the amount is paid off. Remember, too, that when you make payments, part of payment goes to paying interest and part toward your principal or balance.

For the sake of argument, let’s say you have a $15,000 balance on your card, but you’re strapped for cash, what with your rent and utilities and a cut in income due to the pandemic. For ease of calculation, say your card’s annual interest rate is 20% and you’re required to pay a minimum monthly payment of, say, 3%.

This is the breakdown for the first month of your debt:

Principal: $15,000

Payment: $450

Interest: ($15,000 x 20%)/12 months = $250

Principal repayment: $450 – $250 = $200

Remaining balance = $14,800 ($15,000 – $200)

These sorts of calculations are carried out every month until your debt is paid off. Which is why paying only the minimum interest seems as though the needle isn’t budging on your debt. That’s because it’s barely doing so.

The bottom line

This is why you should aim to pay off your entire bill at the end of each month, rather than making minimum payments, which can go on into perpetuity. This is good for the lending institution but not good for you because that interest you’re repaying each month could instead have been channelled to boosting your emergency or retirement funds (and no, it is never too early to start saving for retirement), for example, and aiding in your quest for long-term financial well-being. If you can’t pay off the entire amount, at least strive to reduce your debt by paying more than merely the minimum balance.

Don’t be crippled by fear of debt. Knowledge is your best tool to navigate it responsibly. Use it.