Bad debt and good debt are two completely different things. Despite what you might think, some debt is good. There are times in life when you need to go into debt to see long-term gains. A prime example of this is buying a house. You need to be in debt to get a mortgage loan so you can buy the house. Eventually, you repay the debt and make a profit by selling your home.
As a result, we usually classify good debt as any debt that yields benefits in the future. Student loans can be another example, providing you with the educational qualifications you need to have a good job.
On the other side of the spectrum, bad debt is debt that isn’t advantageous in any way. You owe lots of money to different organizations or people, with hardly anything to gain in return. Avoiding bad debt is crucial if you want to maintain financial independence and stability. Some people think this is harder than it sounds, but is that true?
No! Avoiding bad debt is very easy. All you have to do is avoid situations that land you in massive amounts of bad debt. Today, we’ll look at some of these situations and explain why they land you in debt and how to avoid them.
Credit Card Debt
Credit card debt is one of the most common types of debt in the US. Millions of people end up with credit card debt every year, and it can become a significant problem. This type of debt has massive interest rates attached, so it keeps getting bigger and bigger. The longer you go without paying it off, the more debt you’ll be in.
To avoid credit card debt, you need a fundamental understanding of how credit cards work.
In essence, they’re like mini loans you get each month. When you sign up for a credit card, you get a card with a credit limit. This stipulates how much money is on this card each month. You can buy stuff with your credit card and then pay the bill at a later date - usually the next month. If used correctly, you will pay your credit card bill in full every month, clearing any debt.
Unfortunately, most people don’t do this. Credit card companies set a minimum payment on credit card bills, which is the minimum you can pay. If you do this, you’ll have to pay the rest of your balance plus interest at a later date. Already, you can see how this easily spirals out of control. You start owing more money, yet keep meeting the minimum payments, so everything piles on top of each other.
The key to avoiding credit card debt is two-fold:
Only use as much credit as you can afford to repay
Pay your monthly credit card bills in full to avoid excess payments
Set up a direct debit via your bank account to pay the credit card bill in full. It’ll automatically take what you owe from your account each month, eliminating any interest payments. That’s why it’s critical to only buy what you can afford with a credit card, ensuring you have enough money in your bank to pay the bill.
You will not end up with mass amounts of bad debt - and you actually see the benefits of credit cards, which include improving your credit score and spacing out payments to help manage your finances.
Bail Debt
Bail debt is far less common than credit card debt, but it can be more devastating. This refers to instances where you may get arrested for a crime. It doesn’t have to be a serious crime, but you could still be arrested for things like excessive speeding in your car or disturbing the peace.
When this happens, the local court will set bail for you. This is the amount of money you have to pay to be allowed out of prison before your proper trial. Sometimes, bail amounts can be extremely high, meaning you have to either take out a loan or seek out bail bonds.
Most individuals opt for the latter, in which case a bail bond agency fronts the bail for you and charges a fee for the service. If you attend your court dates and don’t get convicted, your bail is returned and no money is lost. Problems happen when you do get convicted or miss your court dates. You’ll have to pay the full bail amount back to the bail bond agency, leaving you in serious debt.
To avoid this situation, follow these simple rules:
Don’t get arrested and always follow the law
Make all of your court dates if you do get arrested
Obviously, being a good citizen and not breaking the law eliminates this situation from ever occurring. But, if you do get arrested for whatever reason, be sure to adhere to the terms of your bail and attend every appointment necessary. This stops you from forfeiting bail and prevents a lot of debt.
Short-Term Loan Debt
Sometimes referred to as payday loans, short-term loans provide some of the worst debt out there. In some ways, this is similar to credit card debt in that the interest rates are ridiculously high. If anything, short-term loans are considerably worse as you don’t get the benefit of avoiding interest rates by meeting monthly payments in full.
You get a loan to help cover the cost of something and then need to pay it back with interest. The interest is so extortionate that you struggle to make the necessary payments and fall quickly behind. Before you know it, you’re in thousands of dollars of debt.
There is an obvious solution to avoid this type of bad debt:
Dont take out any short-term loans
In all honesty, there is never a reason in life why you should need a short-term loan. A lot of the time, when people get these loans, there are better financial products to choose from. For example, if you want to buy a new car, look for an auto loan or a PCP finance deal. These days, lots of websites and businesses offer the chance to pay for expensive things in installments too. So, if you desperately need a new washing machine, you can usually split the costs up with better interest rates and a more manageable payment schedule.
Short-term loans are the worst financial product out there as they feast on the unwealthy. They’re almost specifically designed to capture the poorest people in society and encourage them to get some extra money. In reality, all they do is slap massive interest rates onto things and lead to bad debt.
Manage your finances and create a budget for every month. This will help you control your spending and save a lot of money too. Saving money is crucial as it prevents you from needing short-term loans. If emergencies happen, you should have some cash to fall back on to cover unexpected costs. Likewise, it pays to get as much insurance as possible. Things like health insurance, house insurance, and auto insurance protect you in case bad things happen. Again, you minimize the potential need for short-term loans and can avoid this type of debt.
There are other types of bad debt out there, but these three are the worst. Why? Because they have the potential to land you in serious debt that’s very hard to get out of. Follow some of the tips outlined in this guide to avoid getting yourself in these situations, reducing the amount of bad debt on your shoulders.
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