If you’re planning on jumping into van life, it may be a good idea to take some time and review your financial situation before your kicking off your adventure. More specifically, you should consider how to handle your debt before you embark on a long-term trip or total change in lifestyle.
If you don’t, you could find yourself in a financial pickle or constantly stressed. Or both.
Here we’ll take a look at some aspects of finances in regards to debt that you may want to consider before hitting the road.
Good debt and bad debt
There are those who would advise you that there is only one kind of debt– bad debt. This isn’t necessarily true because there are some types of debt that have positive outcomes on your potential to save and invest in the future.
Let’s begin with defining exactly “good debt” and “bad debt” is:
- Good debt is owed for things that can enhance long-term earning potential and ideally with minimal risk. Taking out a student loan may improve your earning potential in your career. A mortgage allows you to gain equity in a large purchase, and has opportunities for growth. A business loan, of course, helps grow your business.
- Bad debt is money owned on consumer items or anything that depreciates in value. For most people, bad debt is found on credit cards for which the outstanding balance is not paid off every month. It is usually used to purchase consumer goods, food/drink and entertainment.
With interest rates currently so low for savings, it’s probably never worthwhile saving over paying off debt — however it’s always a good idea to have access to emergency cash. When it comes to paying off debt vs investing, you could do either, or both, depending on the debt(s).
If, for example, your debts have low interest rates and you’re able to comfortably pay the monthly payments, it may be worth considering coming up with a plan to invest and pay the minimum each month on the debt.
However, to do this you will need to be disciplined.
For example, I have a very low interest loan of $20,000 over 5 years. The smallest interest rate you can imagine, 2.5%. I can comfortably cover the monthly payments and the loan is very flexible – I can take a payment break or pay off extra whenever I want without any fees.
Whilst part of me feels I should pay it off ‘because it’s a debt’ and I hate debt (I mean I really debt – I hate owing anybody anything!), the other logical part of me knows I have done the right thing.
What did I do?
I put the loan in a ‘quick access’ stocks and shares ISA. An ISA is a tax-free way of saving in the UK (it means when I withdraw it there is no tax to pay) and I can withdraw all or part of it at any time quickly – within a few days. Whilst stocks and shares can fluctuate in value, I’d expect to see a significant increase over 5 years.
The interest I’d hope to earn is 10-15% per year (the past 12 months has been 20%), which would give me around $17,000 interest in 5 years’ time, whilst the 2.5% loan would have only cost $2,662 leaving a very nice tax-free profit.
What about higher interest debt?
If you have credit card debt, it is pretty-much always recommended that this be paid off first and foremost.
Interest rates of 15-25% will keep you in debt and eat your money; not good for van life. And higher interest rates such as payday loans are crippling at 600% (they are evil and should be banned!).
The first thing do with these sort of loans is know where you stand: the balance, APR interest rate, what you are paying (and what percentage is actually paying off the debt vs paying interest!). Once you know this, you can come up with a plan to address it.
Your plan should be to pay off the highest interest debt first.
In many cases, you may be able to pay off a high-interest loan with a lower interest one and there could be considerable savings to be made.
For example, if your current credit card is 25% but you can get a loan for 10% or possibly even a 0% teaser rate, you can come up with a plan to rapidly reduce your debt by switching it to the other provider.
So, should you pay off debt, save or invest before living in a van?
Maybe. In order to decide what to do, you need to compare the expected return on your invested money as a percentage (and the associated risk) with the amount of interest you’re paying on your debt.
I tend to have a mid-high risk tolerance in terms of investing, however I’m much more risk-adverse when it comes to debt (did I mention I hate debt?!).
Personally, I’d probably pay off any debt that’s at an APR of more than 5%, regardless of the investment opportunity. Especially if the debt has strict terms, is mid-long term and the interest rate has potential to increase.
The goal is to set yourself up so you’re earning more interest than you’re paying. And the riskier the investment, the more significant you will want this difference to be.