Your 20’s are the years you explore who you are, what you like, and the future you want for yourself. This is when you make mistakes, learn lessons, and develop character. It’s also the years when you build your foundation for the future. Decisions made in your 20’s can determine the ease of life in your 30’s, 40’s and beyond. This is why you need to ensure that the decisions you are making now are ones that will help secure financial wellness. However, too often we see young adults spend their 20’s making poor choices that inevitably lead to financial hardships. In this post we explore the effects having poor debt management in your twenties can do to your life.
What Is Debt?
Let’s start by defining debt. Debt is something, usually money, borrowed by one party from another. Debt is used by many corporations and individuals to make large purchases that they could not afford under normal circumstances . A debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, usually with interest. Debt is a great tool for those just gaining independence and want to further themselves in life. For example, debt can be used to pay tuition for a program that will put you in a position to earn more money. It can even be used to start/expand a business.
“Debt is used by many corporations and individuals to make large purchases that they could not afford under normal circumstances”
What Is Poor Debt Management?
Poor debt management means handling your debt in a way that results in financial hardship and stress. There are different activities that can be classified as poor debt management. Here are a few:
1. Paying only the minimum payment on your debt.
This is a bad idea because the less your monthly payments the more you’ll end up paying in the long run. How does this happen? Well, by making minimum payments you’ll end up paying interest on the balance remaining. If you’re using a credit card you can end up paying as much as 29% in interest. This adds up, and overtime, can result in you paying twice as much as you initially owed. The table below illustrates that by paying ~$166 over the minimum monthly payments, you can pay off your debt 6 months earlier and save over $600 in interest payments.
2. Taking out too many loans
Debt should be thought of as the last resource. There are a multitude of different avenues that you can take to fund your daily or business activities before considering loans. While debt is not bad, TOO MUCH debt is bad for several reasons. The primary one being the burden to make monthly payments increasing as your debt grows. That is, the more debt you accumulate, the more the amount you have to pay each month. If that payment amount becomes unsustainable, the worst case scenario is you’ll have to file bankruptcy.
3. Ignoring your debt altogether
The fact is ignoring debt does not make it go away and this is the worst kind of debt management. It means you’re taking no action to actively pay off your debt and are probably taking out more debt than you actually need. The end result of ignoring your debt obligation is always bad.
What Are The Effects of Poor Debt Management In Your Twenties?
It should come as no surprise that there are persons in their 20’s who manage their debt poorly. For a while, I was one of them. In your 20’s you’re taking vacations, going to lounges on Friday nights and having brunch on Saturday mornings. You want to decorate your new apartment with colorful furniture and drive that brand new car you’ve always wanted. Unless your parents are wealthy, it is unlikely that you’ll be able to fund all these activities on your own. So, being young and inexperienced, many young adults will fund their lifestyle with credit cards, which is one of the most popular and costly types of debt.
So, why does poor debt management have a greater effect in your 20’s? I’ll tell you:
1. Bad credit scores
For those who don’t know, a credit score is a number between 300-850 that depicts a person’s credit worthiness. The higher the score the more creditworthy a person is perceived to be by lenders. While the exact calculation of the score is a mystery, it is generally influenced by 5 factors: amount owed, payment history, credit mix, length of credit history and new credit. Of the 5 factors, payment history is the highest weighted factor that affects your credit score. Inconsistent monthly payment can lead to a lower credit score that in turn can affect your prospects to secure future loans. Moreover, even if you do secure future loans, you’ll be paying high interest rates because lenders perceive you as more risky.
2. Potential lifetime of financial hardships
In my opinion your 20’s should be used to lay the foundation of your financial wellbeing. While you’re enjoying your youth, be mindful that any decision you make can affect you for a lifetime. Debt management is no exception to this. For example, it’s easy to damage your credit score and derogatory marks such as late payment, collections, bankruptcy or foreclosure can take years to remove. In some cases these remarks can remain on your credit report for up to 7 years. Therefore, your decision to ignore your private student loans after graduating from university can affect your chances of obtaining a home loan in your mid 30’s. If your debt snowballs and becomes bigger and bigger, you’re now having to borrow from your future to make current debt payments. So, rather than saving for retirement, you’ll spend your 30’s and 40’s paying off the massive debt you accumulated in your 20’s. This leaves you vulnerable to financial hardships even after retirement because you have not saved enough.
3. Missed Opportunities
Success looks and feels different for everyone because we all have different goals. However, poor debt management has universal consequences. In addition to the effects described above, there is the opportunity cost of poor debt management in your 20’s. You’ll now have to spend your 30’s and potentially your 40’s cleaning up the poor decisions you made in your 20’s. While you’re trying to pay off your debt, you’re not saving as much as you could have had you managed your debt effectively from the start. You’ll also invest less which takes away from any future wealth that you could have accumulated. You may also end up paying much more for any endeavors that you want to pursue that will need funding such as student loans to pursue an in demand skill, a home loan, or a business loan. The compound effects of this can be great.
The Bottom Line
The effects of poor debt management in your twenties can have lasting effects. If you find that you have poor debt management habits, it’s not too late to turn your finances and future around. The sooner you recognize it the sooner you can change. However, proper debt management should not be thought of as the end all be all. There could be other behaviors that are hindering your ability to effectively manage your finances. Check out this blog 5 Common Habits Keeping You Broke for tips on how to change these habits for good ones that will improve your financial future.