Understanding the difference between good debt and bad and harmful debt, will make a huge difference in your life. It will be the difference between whether you are forever enslaved by debt or are able to live a happy and financially free life with debt as your friend.
It’s nearly impossible for most of us to live a life that’s completely free of debt, nor do I think we should be completely debt free, because there are different levels of debt. Most individuals can’t afford to pay cash for larger expenses such as a college education or the cost of a new home. But, with careful planning and the use of a personal budget we can show you how to use debt to control your finances and to have the cash, the financial resources and the knowledge to handle those big purchases.
Recognizing Bad and Harmful Debt
The fact of the matter is that most of us take out loans simply to purchase things like groceries, clothes, entertainment and vacations. These loans are in the form of easy to get credit, like Paycheck Advances, Personal Loans and Credit Cards. They are generally high interest loans with relaxed repayment options. They are really easy to apply for and are generally pushed on us by credit providers. These are loans that encourage us to live beyond our means and are therefore considered bad and harmful debt.
Bad debt consists of purchases that you make that have no intrinsic value after they are purchased. Only personal gratification.
Harmful debt is spending on bad debt in amounts that are greater than your income can support.
Is my Credit Card debt doing me harm?
Great question. Well here is a simple test. Ask yourself honestly; Are you able to pay off the entire monthly card balance at the end of each month? If you answer no, then sadly, you may be living beyond your means.
If you find yourself with this type of debt, remember that you are not alone, there are thousands of individuals that are dealing with this right now. Similarly, there are many people that have been through this same sort of struggle, and have turned their lives around and begun a life of financial security.
To reverse this habit, I say habit, because overspending is a habit, you will need to go through a complete mind set change. A change in your thinking, a change in your habits, and a change in the way you view debt. A complete change in the way you view Spending and Saving.
Simply put, “You have to LOVE saving money – MORE – than you love spending money”. It’s that simple.
How Do I Get Rid of This Bad Debt Trap
If you have bad debt, then you need to take the following 3 steps to get back on stable financial ground:
- Start with your budget. Read about the a budget planner here. Write up your income and all your living expenses. Work out what you have spare, your surplus. This is what you are going to use to pay down your debt.
- Work out which loans cost you the most money. That is, which loans have the highest interest rate and start with those loans first. Usually they will be Credit Cards. If your financial position allows it, you may want to a consider a debt consolidation loan. This is usually a personal loan that has a lower interest rate than other lines of credit. You use this loan to pay off all other high interest debt. Then use your surplus to pay this debt down as fast as you can.
- Cut up your Credit Cards, you need to get rid of them. Some card companies will let you shift your balance to them and get a interest rate freeze. This will save you some interest. But only do that if you’re going to pay down the debt. Then cut up the card so you can’t use it.
This process can be painful. You need to remember your new self. You need to fall in love with saving money, and remember the pain of mounting debt every time you want to spend on something not included in your budget.
If you find yourself in this type of financial difficulty again, don’t allow your pride to get in the way or prevent you from receiving help, especially those who are there for you and willing to lend a hand. Talk with someone and get some help.
Some Other Categories of Debt
Bad but Necessary Debit – Unfortunately there is just some debt that you do need. It’s not ideal, but necessary. Such as a car loan, you need to get to and from our daily jobs, because without it you can’t generate an income. Its not effective debt, for example, if you bought the car on credit, it will depreciate the minute you drive it off the dealer’s lot. Necessary debt because you need it to generate your income, but not effective because the debt will be greater than the value of the item purchased.
Good but Necessary Debit – Sometimes it makes sense to borrow money to pay for a Home or Higher Education; A Home Loan is considered good, because you can build equity, a type of forced saving, but not highly effective because, you have live in it, so you get no residual income and often, you may be able to rent somewhere else, cheaper than your current monthly repayments. Higher Education is also good, as you get better educated this can lead to a better income. But not effective because, there is no guarantee of a better income, just the promise.
Highly Effective Debt – This type of debt is the form that rich people use all the time. It’s the type of debt that, if used correctly can make you wealthy. This is debt to purchase assets, like property, shares and businesses. Assets that a) Generates an income, which offsets the repayments. b) Grows in value over time, which makes the debt smaller than its value. c) Generally the repayments are tax deductible.
The secret to wealth is to consistently spend less than you earn, and save the surplus. Use the surplus and Highly effective debt to purchase assets, that will grow in value and continue to produce income long after the debt is paid.
Get a Firm Handle on the Money You Spend
To save money, purchase only the items you absolutely need then write down everything you buy and how much you spent. By cutting back on the things you don’t really need, you can save that money and apply it to a better financial future.
Now that you have a handle on your debts, it’s time to manage your surplus income.