Identifying Debt: The Good, the Bad & the Ugly
Hello life lovers! In the spirit of Halloween, I thought we'd talk about one of the scariest horrors of the 21st century: debt. Dum...dum...daaahh. I know a lot of you were thinking clowns, but you can punch a clown in that big red target of a nose. Meanwhile, debt is pretty much Jason Vorhees living in your wallet. Or at least that's how most people view debt. In all actuality, however, not all debt is bad. Some debt can even be beneficial to your financial fitness. So today, we're going to categorize some examples of debt.
The Good
For many people, the term 'good debt' seems contradictory, but I can assure you it exists. Think about this for a second, if you could take out a loan that would help you generate income, wouldn't you consider it a good investment? Taking out a student loan can do just that. Provided you are diligent in your academic pursuits, college degrees can pay for themselves within a couple of years. Also, student loans generally have lower interest rates than other types of loans.
Another example of good debt would be a mortgage. Mortgages typically stay in the single digits in terms of interest rates, similar to student loans. There are several benefits to having a mortgage, with my personal favorite being that the interest you pay throughout the year is tax deductible. Another benefit of having a mortgage is that as you pay it off, you build equity in the property which you can borrow against in the form of a home equity loan. Home equity loans are good or bad depending on how you use. These loans typically have a lower interest rate than auto loans and credit cards. However, one of the drawbacks can be an increase in your monthly mortgage payments.
The Bad
Bad debt is the type of debt that almost every adult has to deal with at one point or another. Bad debt can be defined as debt that is used to acquire items of degenerating value. The most common form of bad debt is credit card debt. Now that's not to say you should never use a credit card. In fact, we'll be discussing the proper use of credit cards next week as we prepare for holiday shopping. The truth is, credit card debt is only bad when it's excessive. Credit card interest rates can be fairly high depending on your credit score at the time that you apply for the card. Consumer loans have less interest but as with credit cards, the usage of these loans dictates whether it is bad debt.
An example of incurring bad debt could be something as simple as using a credit card to go clothes shopping. Buying those $200 Jordans may feel good, but if you don't pay back the balance before your next statement you're going to end up paying more than what they're worth and the longer you take to pay, the higher that difference becomes.
The ugly
Now we get to the absolute worst of the worst. During troubling financial times, many desperate individuals will contemplate using a cash advance loan, also known as a payday loan. This type of debt should be avoided like the bubonic plague. For those unfamiliar with this deplorable practice, payday loans are designed to provide short-term relief for a fee plus interest. In some states, the interest rates attached to these loans have no cap. This means the lender can legally charge 300% interest. The term for these loans is set for the borrower's next payday, essentially costing them more money in the long run.
Fighting Back
The easiest way to avoid bad and ugly debt is to thoroughly budget your money. Planning your finance is essential to getting out of debt and staying out of debt. To effectively budget, you must first look at how you spend money on a monthly basis. You'd be surprised how much the average person spends on fast food in a month (I was in the triple digits just from lunch). Assigning a spending cap on the various commodities of life (food, clothes, car payments, mortgage, etc.) will be a big help to freeing up some of your income for paying off debts. Click here to download our free budgeting worksheet. You can also check out the budget workbook in our store to help you budget for an entire year.
In addition to budgeting, debt consolidation is another way to deal with your debt. You hear advertisements for these services all the time but hardly anyone explains what it actually is. Debt consolidation is taking out a loan with a lower interest rate than your current debt. So let's say you had a credit card with a 10% interest rate. If you were able to take out a loan with a 4% interest rate, you'd be able to pay off the credit card and have a lower monthly payment for the loan than you did with the card. The interest rate for any debt you incur should be the determining factor because it's ultimately the price you're willing to pay to borrow money.
When you look at how debt really works you can understand how to use some of it to your advantage. Keep in mind, not all debt is beneficial or detrimental to your credit, but we'll talk more about credit later this month. The most important thing to remember when dealing with debt is to stay in contact with your lenders. Ducking their phone calls just makes it look like your trying to dodge them and eventually they'll sell the debt to someone else, dealing a heavy blow to your credit score in the process. Losing your job or missing work are things that can easily affect your ability to pay back a debt. Rather than screening your calls, take the initiative and call your lenders to ask about extensions and split payments to help you recover from a loss of income. Be sure to subscribe to Yagoli.com for more financial fitness tips and share this article to help others gain awareness.
