Do you think that debt free living is possible? Of course it is. All it really takes is some self control and a good amount of savings to finance whatever you will need in the future.
But does that mean you should pursue this financial condition? Not really. You see, there are good and bad debts that has different effects on your financial future. According to an article published on Bankrate.com, debt is quite a complex idea. It is not all good, but it is also not all bad. The article continued to state that if you want to be smart when it comes to your money, you need to able to differentiate between a good debt and a bad debt. If not, you might find yourself in big trouble in the future. It is said to be a logical difference between the two – a difference that according to the article, is missed by a lot of Americans.
Obviously, you want to be able to identify this difference before you borrow money. But even if you already accumulated the debt, you should still identify which of your debts are good or bad. This will help you create a better strategy to get out of all your credit obligations.
Tips when it comes to paying off your good debts
Let us begin with your good debts. Differentiating your good and bad debts, at this point, will merely depend on the answer to this question: which debts help increase your personal net worth? Anything that will not increase your financial wealth can be considered as a bad debt.
If that is your definition of a good credit obligation, then you can assume that home loans, student loans and business loans are part of the good debts. Anything that will help you increase your money is a good debt. A home loan will help you increase your net worth as you continue to pay it back. As you pay off your home loan, you will be owning more of the home equity.
When it comes to student loans, an education will help you get the skills that you need to be able to ask for a higher salary from your employer. For business loans, well it will help you earn through your own company.
These three are among the debts that you can consider to be good for your financial future – at least, if you pay them off properly.
But how can you do that? Here are two tips when you are dealing with good debts.
Know when to be aggressive in payments or when to put it off.
When we say put it off, that does not mean you will not make any payments at all. There are both good and bad debts that you can pay off aggressively if necessary – without you having to pay a prepayment penalty charge. However, you also have to understand when it is right to be aggressive with your payments and when to be content to just pay the minimum required.
For instance, student loans usually allow you to pay off more than the required amount so you can get out of it faster. But if you still have to build up your emergency fund, then it is better for you to just satisfy the minimum required and allocate your extra money towards your savings. Or it can be sent towards your investments. But if your savings account or your investment turns out to have smaller returns compared to the interest rate on your student loans, then prioritizing your loan payments will save you more money.
Monitor if it is holding back your financial growth.
The next tip is to check if your loans are hindering your financial growth. If the interest rate is proving to be eating off more of your money than it should, then you may want to focus on debt payments so you can get rid of it easily. But if it is not really hindering your financial success, then you can let it run its course as you focus on other financial needs in your life.
For instance, if your home loan is keeping you from moving on to green pastures in terms of your career, you may want to consider getting rid of the house. You can do this by selling it off and letting the new owner take over the payments.
Tips when it comes to paying off your bad debts
In truth, there is not much difference in paying good and bad debts – unless you consider the urgency by which you need to get out of them.
Bad debts are the debts that take money from your pocket without contributing anything towards your financial growth. These include credit card debts, car loans and payday loans.
For credit cards, we usually fall under the trap of buying junk just because we think we can afford it. When you buy through cards, you are using money that is not yours. You have to pay it back and it is usually with high interest. The same is true for payday loans. You will never win with this type of loan because of the high interest rate that you have to pay for it.
In terms of the car loans, this is a tricky debt to be in. Some people believe that it is necessary to make your life comfortable but you also have to remember that it will never increase your personal net worth. A car depreciates as soon as you drive it off the dealer. If you bought it using a loan, you will end up paying more for it than the current value of the car. That makes it a bad debt in our eyes.
So what can you do to help you pay off bad debts more efficiently?
Weigh the debts you need to pay first.
If you have home loans, student loans, payday loans and credit card debts, you may want to consider paying off your credit cards or payday loans first because it has the highest interest rate among all three. You are actually losing more money if you let your card balance run for a longer time. In fact, an article from Kiplinger.com ponts out that sticking to the minimum payments keep us in credit card debt. Do the math and calculate which debts will be costing you more – then you can concentrate on that one.
Know your options to get out of debt.
In case your money will not allow you to pay off your good and bad debts aggressively, you may want to seek out debt relief options that can help you out. You have debt consolidation loans, debt management, debt settlement and bankruptcy as some of your options. See which of them is suited to your specific debt and financial situation.
Understand when it is time to sacrifice your credit score
As you make your choice between the debt relief options, you need to prepare yourself for the time when you need to sacrifice your credit score. When your finances is not enough and you need a debt reduction to handle your bad debts, then your options include debt settlement and bankruptcy. Both of these will damage your credit score to some extent.
Defining good and bad credit accounts
As you work on paying off your debts, you need to learn further how to distinguish good and bad debts. An article from CNN.com defined good debts as purchases that you need but cannot afford to pay in cash. But beyond that, it is also debt that you can afford to pay. On the other hand, bad debts are those that you purchase on credit but you do not really need – at least, not immediately. These are also the debts that you cannot afford to pay back.
To help you distinguish the good loans from the bad loans, here are two questions that you may want to ask yourself.
- Is it a one time credit purchase or do you see yourself needing this type of credit for a long time? If it is the former, that is a good debt. If it is the latter, that is a bad debt. Although there are certain moments in our lives that require us to borrow money, it should never be a means to support a lifestyle that you cannot afford. If anything, it should help you temporarily – but you need a more solid game plan to finance a need.
- Is it worth the money you will waste on interest? If yes, then it is a good debt. If not, then it is a bad debt. The benefit of borrowing money to make a purchase is usually convenience and getting something immediately. The downside is you have to waste your hard earned money on the interest.