I recently wrote about good debt, going over cases when debt can actually be beneficial for building wealth. The vast majority of debt, however, will hinder your finances, tie up your income, make you a slave to your job and do nothing to help you reach your financial goals. This bad debt, as one may call it, is what I am going to talk about today.
Why is Most Debt so Bad?
Believe it or not, that’s actually a valid question. Many people grow up with a notion that debt is normal and acceptable. They are not necessarily to blame – our entire consumerist society revolves around credit. Even worse, good financial principles are barely taught in today’s schools.
If you think that debt is good or in some way beneficial, consider the following:
- You waste money due to interest. It’s a simple concept. You borrow money to buy something you want now and pay interest in return for the convenience. Most types of bad debt have high interest rates and can cost you hundreds and thousands of dollars because of it.
- Debt ties up your income. Monthly payments use up your income and reduce your ability to save and invest. If you have a lot of debt, you may find yourself in a situation where you don’t have any money to spare after your bills and debt payments are added up – definitely not a good thing.
- You live on the verge of bankruptcy. Everybody’s situation is different, but many people with a lot of debt are actually just a couple of paychecks away from bankruptcy. They may seem fine now, driving their fancy cars and going out to eat every day. But if they lose their job, all of those things (and more) will be gone because they will be unable to make their payments. Bad debt takes away your freedom and forces you to be a slave to your job.
- Debt does nothing to get you closer to your goals. Sure, debt can allow you to go to Hawaii for Christmas. But aside from instant gratification that quickly dissipates, bad debt does nothing to get you closer to your financial goals. It will not help you become financially independent or retire. In fact, it can significantly hinder your progress.
Now that you have a better idea why you should stay away from bad debt, let’s look at some common types of debt to avoid.
Consumer debt is used to purchase material possessions that hold little value and that are not considered assets. It includes using credit cards or loans to buy clothes, electronics, furniture or vacations. Consumer loans and credit cards have some of the highest interest rates of all types of debt.
Since we are constantly bombarded with advertisements telling us how easy we can buy something on credit, consumer debt may be hard to resist. But once you realize that it is not impossible to live a great life and remain debt free and that “keeping up with the Joneses” will only jeopardize your future, you won’t be so quick to pull out your credit card next time you shop.
Due to their high cost, nice cars are hard to afford without taking out a loan. It is much easier to pay $299 a month than $30,000 up front. But what is the purpose of your vehicle? To show off to your friends? How do you justify a brand new Mercedes, if all you need is a means of transportation?
The truth is that you can buy a reliable used car with great gas mileage for just a few thousand dollars. If you start saving in high school or college, you can buy your first car using cash in just a few years. The vast majority of car loans can be easily avoided. Your ego might suffer, but your wallet will thank you.
Education is a worthwhile cause, but student loans can be a significant financial setback for new college grads. Don’t assume that they are the only way you can get a good education.
There are plenty of ways to earn your degree while avoiding student loans completely. See if you qualify for federal student aid and be sure to apply for scholarships. There are thousands of organizations willing to give you free money – you just need to be proactive and fill out an application. You can also consider going to a cheaper school, or taking general education classes in a community college before enrolling in a university.
Other Types of Bad Debt
Avoid payday loans, personal loans, debt consolidation loans and other high-interest debt. It is going to cost you a lot of money thanks to interest and it will not help you build wealth. Bad debt is often a result of selfish wants, not legitimate needs.
Tips for Avoiding Bad Debt
It is absolutely possible to live a fulfilling life without debt. Use the following tips to help you:
- Always have a budget. I can’t stress this enough. A monthly budget is the first step to taking control of your spending habits and eliminating credit card usage.
- Save ahead for large purchases. If you want to buy something outside of your normal budget, save for it ahead of time. Write down all large purchases you plan to make in the next 5 years and begin saving for them now. It’s much more satisfying to buy something you saved for, trust me.
- Build up an emergency fund. An emergency fund will help you avoid borrowing money to cover medical expenses, periods of unemployment or unforeseen car repairs. Start by saving 6 months worth of expenses in a high yield savings account.
- Live below your means. Evaluate your lifestyle and find ways to save money. Expensive things, dinners or vacations do not necessarily lead to a happier life.
- Shop around and find bargains. With just a few hours of research you can save hundreds or thousands of dollars on most purchases. Look for sales, discounts and promotions, and don’t be so quick to buy the latest gadgets or electronics.
Adopt a debt-free attitude early in life, pay off any debt you already have and set yourself up for financial success in the future.
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Image source: Chris Potter