Good And Bad Debt
Debt in and of itself is not a bad thing. So we understand what debt is and why some debt is great debt. Debt allows you to do things you otherwise normally could not do, such as start a business, go to college, or pay for a home. Debt constructs buildings and funds investments and entire corporations-even the government is funded by debt. The trick is to foster debts that help the cause and banish the ones that don’t. Not all debts are bad debts.
Good Debt
Debt that helps you, enriches your life, is manageable, and is not a burden can be called good debt. For example, student loans are good debt if they enabled you to get through school and further your life goals. They are bad debt if you dropped out of medical school after one year to become a writer. A good debt helps; a bad debt hinders. We want to help you get rid of that bad debt. Other examples of debt that may be considered good include
Home loans. A mortgage can be a great debt. Not only does it permit you to own your own home, but it also allows you to build home equity. It is an asset. As Chapter 23, “What the Rich Know That You Don’t,” explains, people who are financially savvy earn interest and equity. People who are not financially savvy pay interest and create money for others. For example, charging groceries means that you will pay about 17 percent interest on items that will be consumed within a week. A financially literate person would never do that.
Money Talks
In 1997, 66 percent of all families owned their own home, the highest rate of homeownership ever.
Car loans. A car loan can be a fine debt because you get something long-lasting out of the debt. If you need a nice car for your job (if you are a real estate agent, for example), a car loan may be considered good debt because it helps you in your career. However, a car loan that you cannot afford is a bad debt because it detracts from your life.
Business loans. If you can service the loan, and it helps you make more money, the loan is good debt, but if the loan is nothing but a source of problems for you, the debt is bad.
Credit cards. Credit cards are fantastic. They are convenient and easy. They can help finance a business or even medical emergencies. The problem with them, as you probably know only too well, is that it is too easy to fall under their siren spell and get in over your head before you know it. That’s when they begin to hurt your life more than help it.
Bad Debt Blues
How do you know if your debt is good debt or bad debt? Easy. Bad debts cause stress. You sleep poorly because of them. They cause fights and foster guilt. Supreme Court Justice Lewis Powell was once asked to define obscenity. Hard-pressed to come up with a definition, Powell uttered the famous line, “I know it when I see it.” The same could be said for bad debt:
You know it when you see it, and it certainly can be obscene. Bad debt seems impossible to pay back. You create bad debt when you charge things you don’t need or when you borrow for things that you consume quickly, such as clothes, meals, or vacations. The things quickly disappear, but the debt has a nasty habit of sticking around, seemingly forever. Bad debts can become very bad debts because of interest and penalties.
For example, if you buy a CD player for $200 and don’t pay it off by the end of the year, and your credit card company charges a usurious 20 percent APR (20 percent per year), you owe $220 by the end of the year. If you do this with five items, you owe $1100, and that’s a lot of money.
Money Talks
Tight for money? Here are some simple ways to save a little extra: Don’t use ATMs at other banks and avoid $2 user fees; cancel your movie channels on cable and save about $20 per month; put all of your change at the end of the day in a jar and save about $50 a month; hold a garage sale and make about $200; cancel your cell phone and save $50 a month.You can create bad debt when you agree to pay these crazy interest rates that some creditors charge, because the debt seems to grow exponentially. Credit cards are the prime culprit, but they are by no means the only one.
High interest can also come with personal loans, business loans, or unpaid taxes. Because you have a lot of these bad debts, debts you are having a difficult time handling and that cause you anxiety. They are the debts you avoid thinking about, the phone calls you don’t answer, and the bills stuck in a pile. Avoidance dances with guilt only to be tapped on the shoulder by your new suitor, fear.
You know what the bad debt dance looks like, anyone reading this book does: New bills are coming in before you’ve cleared out those from last month. You’re surprised to find that the phone bill is still unpaid. Somehow the dentist was never sent his check. You know what past-due notices look like. Your Visa and MasterCard bills include late payment penalties. The hardware store sends a letter telling you you’re past due and requests that you send a check at once.
There is more month left at the end of your money, and payday seems far away. Worst of all, these things don’t surprise you anymore. Avoidance is a common coping mechanism to deal with a budget that doesn’t balance. The problem is, it can create even more problems than you already have:
Your property could be repossessed. The finance company can come take your car. The electronics store can come take its TV back.
You could get sued. If that happens, your wages could be garnished, or your bank account could be levied upon. Imagine your surprise when you go to get that $1,000 out of your checking account to pay your mortgage and you find that it has been seized by one of your creditors.
A lien can be placed on your real estate. Failure to pay a bill now means that a creditor can get a judgment against you and force you to pay it later when you sell your house, only then you will pay it with 10 percent interest per year.
Loss of services. You could lose your insurance or your utility services if you avoid paying those bills. Yet, as much as you have been avoiding the problem, the truth is that your debts are neither crushing nor hopeless. They are simply a problem-one for which there is a solution. But no one ever eliminated a problem until he or she recognized and admitted that there was a problem,you will need to begin to formulate a debt-reduction plan that will work for you. As you do, you need to determine which debts are necessary and which are not.
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