I’m sure you have heard that there is good and bad debt.
Debt that adds value to your life is considered good debt. Examples include a mortgage, student loans, business loans. These are all items that should increase in value over time.
Debt that is not considered an asset is called bad debt. Examples include personal loans, high interest credit card debt and car loans. High interest credit cards are the hardest to get rid of. The monthly interest charged for not paying off your credit cards on a monthly basis is so high that it could take a long time to pay off even a small balance.
The average American credit card debt among all age groups is $4,392. At a rate of 16% and paying $250 a month toward the debt, it will take 21 months to pay off. The amount of interest paid is $645. So, in addition to taking a long time to pay off you are also paying more than your original balance. New balance with interest is $5,037.
It is considered bad debt because you are paying more for a product that is most likely going down in value. While with good debt, you are paying for something that is increasing in value over time. Making your product worth more in the long run.
Having bad debt can make you feel like you are stuck. Unable to feel the freedom to make big changes in your life. There really is no way around bad debt. Best case scenario is that you can settle with your collector’s, but you would have to go in with a reasonable amount to offer. For example, if you owe $10,000 perhaps you can offer your collectors $5,000 to clear your debt.
Instead of using bad credit to make purchases, do this.
- Budget: A strong monthly budget will have money allocated for all areas that you rely on monthly. Best practice is to track your spending for at least two months prior to creating your budget so that you can get an average amount for each category. Remember home budgets are meant to change often. That’s why it is recommended to budget monthly vs. weekly or yearly.
- Sinking Funds: These funds are created for items that you know are coming up. They are not for monthly bills. These funds are usually held in high yield savings accounts where they can earn interest as you build them. Some sinking funds can be for holidays, car maintenance, insurance, home maintenance and repairs, medical bills and vacations.
Ally Bank is a great bank for sinking funds. They are an FDIC online bank that offers high yield savings accounts with the option of having buckets. You have your main account, which can be your emergency fund and then you have your buckets under that large account. You can automate payments to each bucket separately from the main account as often as you like. The difference between this bank and your regular bank is that they have higher interest rates and no fees.
You can also have sinking funds outside of the bank. You can have an envelope system that works perfectly for this purpose.
- Emergency Fund: Having a fully-funded emergency fund can provide you with the freedom necessary to make a drastic change in your life or to pay for a big expense that you were not expecting. It is recommended that you have at least 6 months of basic living expenses saved.
Be open to living a life without bad debt. I can only guarantee that you will feel like a weight has been lifted. Your outlook on life will be more positive knowing that you have things in place to handle any emergency that comes your way. Lastly, when you have no bad debt, you have choices and time.