Debt is an uncomfortable subject. Discussing our personal finances is somewhat taboo and acknowledging our debt can induce anxiety. American debt hit a record high of $13.2 trillion in 2018. While most of us have some form of debt, many people are unsure about how to deal with their debt.
Simply put, debt is owing money to a person or entity. Debt is not always a bad thing. There are plenty of forms of debt that are completely legitimate and can even help your financial well-being. It ultimately boils down to the amount of debt, the type of debt, and your ability to pay it back by managing your money properly.
Is Debt Good Or Bad?
Not all debt is created equal. There are some forms of debt that can actually help you earn income in the long run, such as a mortgage or student loans.
The key to determining good debt versus bad debt is to think of debt as an investment. Certain debts have ROI’s that can justify taking them on. It all depends on if the asset you are making payments on is appreciating or depreciating.
Credit Card Debt
Credit card debt is a common type of debt and an example of bad debt. People tend to accumulate credit card debt because of its inherent ability to let you spend more than you make.
A common mistake that people make is only making the minimum payment on their balance. Most people believe that as long as they make the minimum payment, they can avoid the fees that come with missing payments.
While this is true, it doesn’t prevent the credit card company from charging you interest on a carried balance. When a balance is carried at the end of the month, the bank will charge you interest for the entire amount.
Medical Debt
Medical debt is another common source of debt for many people. The unfortunate truth is that medical debt often comes from an unexpected injury or surgery. While it is ultimately a form of bad debt, it is difficult to label it that due to its unavoidable nature.
However, there are ways that you can manage medical debt. Payment plans, medical credit cards, and medical bill advocates are all resources to help you chip away at medical debt.
Car Loan Debt
The ultimate determinant of good debt versus bad debt is if the asset depreciates in value. Obviously, anything that loses value over time is bad debt. A car is a great example of one of these things that loses value over time.
Many people will lease or buy brand new cars that have high monthly payments. When you pay for a brand-new car, you are paying entirely too much money for something whose value depreciates quickly. If you need a car for your commute, it is much better to purchase a used car.
Mortgage Debt
If you are responsible, mortgage debt is a type of good debt that can help build your wealth. A house is likely to increase over time. When you sell, you can make enough money off the sale to pay the lender back for the remainder of the loan and pocket the rest.
Your credit score can also improve if you make all your mortgage payments on time. However, it can turn sour if you take on a mortgage that is outside of your means and ultimately default on your mortgage payments.
Also, people tend to forget about other expenses such as taxes or home repairs. As long as you are able to afford your mortgage payments and any unexpected costs that come with home repairs, you are in the clear.
Business Debt
Because most businesses begin with a loan, small business debt can be an unavoidable part of every small business’s journey. However, if the business is not performing as you had hoped, mounting debt on your small business loan can worsen things for you.
If you find yourself facing a cash flow problem, there are solutions to getting your feet back under you. Refinancing your loan and reducing spending can help you get a handle on your debt.
Student Loan Debt
While student loan debt is a burden that many of us face, it is ultimately considered a form of good debt. There is a positive correlation between your future earnings and having a college degree, so you will likely see more income over your life because of it.
Student loans also have lower interest rates, which can make them more manageable than other forms of debt. Obviously, taking on student loan debt isn’t always a good idea if your degree doesn’t align with your career path. Be sure to consider how your degree will contribute to your career before taking on student debt.
Collections Accounts
Having a debt in collections is no fun. Debt collectors are aggressive, unkind and an overall nuisance. A financial account goes into collections when the original creditor sells the delinquent account to a third-party collection agency.
The hope is that the collections agency can harass you enough to make payments when the original creditor does not want to waste any more resource trying to get you to pay.
When one of your debts moves to collections, this will negatively impact your credit score. This can affect your ability to qualify for certain loans or low-interest rates. Be sure to communicate with your collectors and original lenders if you have an account in collections. Communication can be all the difference.
What Are The Different Types Of Debt?
All forms of debt can be divided into two categories: secured and unsecured.
Secured Debt
Secured debt means that the creditor has an asset that acts as collateral on the debt. The creditor does this by placing a lien on the asset, which is an agreement that allows them to repossess it if you fail to make payments.
Auto loans and mortgages are examples of secured debt. If you do not pay your mortgage or car loan, the creditor will foreclose on your home or repossess your car.
Unsecured Debt
Unlike secured debt, unsecured debt does not have any assets to act as collateral. However, this doesn’t mean that you are free of consequences if you don’t pay.
The creditor of unsecured debt, like a credit card company, may sell your debt to a collections agency that will harass you for payment. If you still don’t pay, they may sue you or attempt to have your wages garnished.
What Happens When You Don’t Pay Your Debts?
When you don’t make payments on a loan, the loan becomes delinquent. If the loan is secured by an asset lien, the creditor will seize the asset and may charge you for additional costs after the auction.
If the debt is unsecured, the creditor will sell the debt to a collection agency. You will then be harassed by creditors until you make payment.
Defaulting on any loan will negatively impact your credit score. A low credit score can prevent you from qualifying for loans, credit cards, or low-interest rates.
How To Get Out of Debt
If you’re worried about how to get out of debt, here are some things to know — and how to find legitimate help. What you can do on your own:
Where do I start?
A budget is a roadmap to plan your finances and keep track of where your money goes. Budgeting is a helpful tool whether you’re working hard to make ends meet or if you have some extra income and want to adjust your saving goals. It will help you see where you spend your money and how you might spend money differently.
To make a budget:
- Gather your bills (utilities, insurance, etc.) and pay stubs.
- Collect receipts for things you typically spend money on like groceries, entertainment, transportation, clothing, and everyday expenses.
- Add up all of your paychecks and any other income. Subtract your expenses from that.
When you’re done, look for things in your budget you might be able to change so you have more money left over each month. Your goal is to stop adding to your debt, and also to pay down the debt you already have, if you can.
You can find information about budgeting and money management online, at your public library, and in bookstores.
If you’re behind on your bills, don’t wait to call the creditors you owe money to. Do it before a debt collector gets involved. Tell your creditors what’s going on, and try to work out a new payment plan with lower payments you can manage.
How Do I Pay All My Debt?
Once you find out how much you owe, then you are ready to make a plan to pay it off and get out of debt. This is typically where people get discouraged. Just remember that you are not the first person to have debt and there are strategies you can use to pay it off.
Debt Snowball
Debt snowball means that you begin by paying off the smallest debts first and then paying for larger and larger debts. This can help debtors feel accomplished early on and encourage them to continue making payments on their debts.
Debt Avalanche
Debt avalanche means that you begin paying off the debt with the highest interest rate. This can be helpful because these are the debts that can add up quickly. Eliminating them first can help the amount you owe from continuing to accumulate quickly.
Debt Management Plan
If you find that you are not making much progress on your own, you may want to consider seeking the assistance of a nonprofit credit counseling agency.
They can work with your creditors to help lower interest rates and eliminate any penalty fees. They will then set up a payment plan for you that allows you to pay off your debt within a few years.
Debt Consolidation
A good way to score a lower interest rate on all your debts is to consolidate them. This allows payments to be much easier to make and you can pay them off in a shorter period of time. You can consolidate debt in a few different ways, such as taking out a personal loan or using a balance transfer card.
Debt Settlement
Debt settlement programs are different from debt management plans. Debt settlement programs are typically offered by for-profit companies to people with significant credit card debt. The companies negotiate with your creditors to let you pay a “settlement,” or lump sum of money that’s less than what you owe.
They agree that this amount will settle your debt. Meanwhile, you have to set aside a specific amount of money every month in a designated account until you have enough savings to pay off any settlement that’s reached. These programs often encourage you to stop making any monthly payments to your creditors.
Debt settlement programs can be risky. If a company can’t get your creditors to agree to settle your debts, you could owe even more money in the end in late fees and interest. Even if a debt settlement company does get your creditors to agree, you still have to be able to make payments long enough to get them settled.
You also have to watch out for dishonest debt settlement companies that make promises they can’t keep, charge you a lot of money, and then do little or nothing to help you. You may not be able to settle all your debts.
While you’re in the debt settlement program you may still get calls from debt collectors and your credit report and credit score are likely to be damaged. The process can take years to complete.
If you do business with a debt settlement company, you may have to put money in a special bank account managed by an independent third party. The money is yours, as is the interest the account earns.
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