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Lesson 3

Understanding Debt & Interest

How debt works, why interest rates matter, and avoiding the debt trap

⏱️ 18 minutes 📚 Intermediate 💰 Debt Management

What You'll Learn

  • What debt really is and how it works
  • Why compound interest works AGAINST you when you're in debt
  • The true cost of minimum payments on credit cards
  • How interest rates dramatically affect what you pay
  • Strategies to avoid and escape the debt trap
⚠️

The Big Idea

Debt makes compound interest work AGAINST you instead of FOR you. Every dollar you owe grows exponentially, stealing from your future while you pay for your past.

What Is Debt, Really?

Debt isn't just "borrowing money" – it's much more significant than that. Let's break down what debt actually means:

Debt is:

  • A promise to pay back money you borrowed, plus extra (interest)
  • Trading future freedom for present spending
  • Someone else owning a piece of your future income
  • A legal obligation that doesn't go away easily

When you're in debt, you don't fully own your paycheck – your lenders get paid first. You're working partly for them, not entirely for yourself.

Good Debt (Rare)

Debt that can potentially increase your wealth:

  • Student loans (if degree increases income significantly)
  • Mortgage on affordable home
  • Business loan for profitable venture

Even "good debt" requires careful planning!

Bad Debt (Common)

Debt that decreases your wealth:

  • Credit card debt for consumables
  • Car loans on depreciating vehicles
  • Payday loans with extreme interest
  • Any debt for wants instead of needs

This is the debt that destroys financial futures.

📖 Tucker's Tale: The Credit Card Trap

Let me tell you about Jamie, who got their first credit card at 18. The card had a $2,000 limit and Jamie thought, "I'll just use it for emergencies and pay it off right away."

But then:

  • A concert came up: $150
  • New shoes were on sale: $80
  • Friends went out to eat: $45
  • A few more "small" purchases...

Before Jamie knew it, the balance was $1,200. "No problem," Jamie thought, "I'll just pay the minimum payment of $25 per month."

The Shocking Reality:
  • Original debt: $1,200
  • Interest rate: 18% APR
  • Minimum payment: $25/month
  • Time to pay off: 7 YEARS
  • Total amount paid: $2,115
  • Interest paid: $915

The Lesson: Jamie paid almost DOUBLE for those purchases! That $150 concert ticket really cost $280. Those $80 shoes? Actually $150. The credit card company made $915 from Jamie's debt.

How Interest Works AGAINST You in Debt

Remember how compound interest is amazing when you're saving? It's equally devastating when you're in debt. Let's see why:

The Debt Growth Formula

When you owe money, the same compound interest formula works in reverse:

Each month:

  • Your balance gets charged interest
  • That interest gets added to your balance
  • Next month, you pay interest on the interest
  • The debt snowballs larger and larger

Minimum Payments: The Trap

Let's see what happens with different payment amounts on a $5,000 credit card debt at 20% APR:

Minimum ($100/mo) 94 months Total paid: $9,332 (7.8 years!)
$150/month 47 months Total paid: $6,999 (3.9 years)
$200/month 32 months Total paid: $6,373 (2.7 years)
$300/month 19 months Total paid: $5,724 (1.6 years)

By paying just $200 more per month, you save $3,608 and get out of debt 75 months (6.25 years) earlier!

Common Types of Debt & Their Dangers

💳 Credit Cards

Typical Rate: 15-25% APR

Danger: Easy to use, minimum payments trap you for years. The highest interest rates of common debt.

Watch Out: "Zero interest" promotions that become 25% if you miss one payment.

🚗 Car Loans

Typical Rate: 5-15% APR

Danger: Car loses 20% value the moment you drive it off the lot, but you're paying interest on the full price.

Watch Out: Long loan terms (6-7 years) mean you'll owe more than the car is worth.

🎓 Student Loans

Typical Rate: 4-7% APR

Danger: Can't be discharged in bankruptcy. Can follow you for decades if you only make minimum payments.

Watch Out: Borrowing more than your likely starting salary.

💸 Payday Loans

Typical Rate: 300-500% APR(!)

Danger: Extremely predatory. Designed to trap you in endless debt cycle.

Watch Out: NEVER use these. There are always better options.

⚠️ Critical Truth: The higher the interest rate, the more you're being punished for being in debt. High interest rates on consumer debt can make it nearly impossible to get ahead financially.

The REAL Cost of Debt

Debt costs you far more than just the interest payments. Let's look at the hidden costs:

Example: The True Price of a $500 Purchase

You buy a $500 TV with a credit card at 18% APR and make minimum payments:

  • Actual cost with interest: $925
  • Opportunity cost: $500 invested at 7% for 6 years = $751
  • Total real cost: $1,676 ($925 paid + $751 not earned)

That $500 TV actually cost you $1,676 – more than 3 times the price!

Beyond Money: The Stress Cost

Debt also costs you:

  • Sleep: Worrying about payments keeps people awake
  • Relationships: Money stress is a leading cause of arguments
  • Opportunities: Can't take a better job if you're stuck paying debt
  • Health: Financial stress causes real health problems
  • Freedom: Every debt payment is work you must do

How to Avoid the Debt Trap

Tucker's 5 Rules for Staying Out of Debt

Rule 1: If you can't pay cash, you can't afford it.

Exception: House (maybe), education (carefully considered). Everything else? Save first, buy later.

Rule 2: Credit cards are for convenience, not credit.

Use them for rewards if you want, but pay the FULL balance every single month. No exceptions.

Rule 3: Build an emergency fund before anything else.

Save $1,000 as fast as possible. This prevents you from going into debt when unexpected expenses hit.

Rule 4: Delay gratification.

Wait 30 days before any non-essential purchase over $100. Most of the time, you won't even want it anymore.

Rule 5: Remember that debt is bondage.

Every debt payment is future income you've already spent. The Bible calls the borrower "slave to the lender" for good reason.

If You're Already in Debt: The Way Out

Debt Snowball Method

How it works:

  1. List all debts smallest to largest
  2. Pay minimums on everything
  3. Attack smallest debt with fury
  4. When paid off, roll that payment to next debt

Best for: Staying motivated with quick wins

Debt Avalanche Method

How it works:

  1. List all debts by interest rate
  2. Pay minimums on everything
  3. Attack highest rate debt first
  4. When paid off, roll payment to next highest rate

Best for: Saving the most money mathematically

Both methods work! Choose the one that will keep you motivated. The snowball gives psychological wins; the avalanche saves more money. The best method is the one you'll stick with.

🎯 Key Takeaways

1

Debt makes compound interest your enemy. The same exponential growth that builds wealth when saving destroys it when borrowing.

2

Minimum payments are a trap. They're designed to keep you in debt as long as possible, maximizing interest payments to the lender.

3

Interest rates matter enormously. A few percentage points difference can mean thousands of dollars and years of payments.

4

Debt costs more than money. It steals your freedom, peace of mind, opportunities, and forces you to work for the past instead of the future.

5

The best debt strategy is avoidance. Stay out of consumer debt entirely. If you're in it, get out as fast as possible and never go back.

📖 Biblical Wisdom on Debt

"The rich rule over the poor, and the borrower is slave to the lender."

— Proverbs 22:7

This isn't just ancient wisdom – it's a timeless truth about debt. When you owe money, you're not fully free. The lender has a claim on your income, your time, and your choices. God's word warns us about debt because He wants us to live in freedom, not bondage. While not all debt is sin, it's always a form of bondage that limits our ability to serve, give, and live according to God's calling.

"Let no debt remain outstanding, except the continuing debt to love one another."

— Romans 13:8

💭 Think About It

  1. Why do you think credit card companies set minimum payments so low? What's in it for them?
  2. If you were Jamie in Tucker's story, what would you do differently from the very beginning?
  3. How does understanding the true cost of debt change your view of credit cards and loans?
  4. What are some things people your age might be tempted to go into debt for? How can you prepare to resist that temptation?
  5. If someone close to you was struggling with debt, what advice would you give them based on what you've learned?

✅ Take Action

🧮

Calculate the True Cost

Use the loan calculator at marks.money to see how much different purchases would actually cost if bought with credit. Try a $1,000 purchase at 18% APR with minimum payments.

📝

Make a "Never Debt" List

Write down 5 things you'll never go into debt for. Common items: clothes, entertainment, food, vacations, electronics. Sign it and keep it visible.

💰

Start an Emergency Fund

Begin saving toward a $1,000 emergency fund. This is your first defense against debt. Even $10 per week gets you there in 2 years.

🎯

Practice Delayed Gratification

Next time you want to buy something over $50, wait 30 days. If you still want it AND can pay cash, then consider buying it. Track how often you actually follow through.