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Okay ladies, it’s time to sort the bad from the ugly and the not so great from the downright wrong. (And we’re not talking about men.) Unfortunately, you might have some or even all of these different types of debt wearing you down. But stop your worrying. You can change how you move forward.
You see, debts come with so much more to think about than just interest rates. You have to look at the total cost and if it will really offer proportionate benefit to your life.
The truth is, not all debt is bad and all debt is not created equal. It’s important to know the difference.
First: Ugly debt
Ugly debts are not only the most costly in interest and related risk, they also hold the highest propensity for easy abuse!
Beware of these ugly debts:
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Car loans and leases
Many of us need a vehicle to accommodate work and family needs, but we are all too easily swayed to purchase more metal than we can afford. For examples of rates, new cars generally have 0–5% financing; used are generally financed at 8%.
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Store financing - no payments, no interest plans
If you don’t pay these plans back in full before the end of the interest-free term, you are back-charged interest from the date of purchase, often at 28%+. Yikes!
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Store credit cards
These cards come with much higher rates than major credit cards, often as high as 24–28%; using them is okay, carrying a balance is not.
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Major credit cards
The rates for plastic are still usually in the high teens, 17–19%. Using them can be acceptable within reason, but carrying a balance is very expensive. Collecting points is a common reason to use these cards frequently, but beware if a card costs you a $100/year fee; in most cases, you have to charge at least $10,000 before you even get the fee back in points value.
Second: Bad debt
Bad debt is less expensive and less dangerous than ugly debt, but that doesn’t mean that it is an effective use of your debt dollars.
Bad debts include:
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Personal loans
The rates are lower here; approx. 8–10% on average. They can still be ugly, however, because they are generally used to purchase things that will never grow in value, such as cars or boats. Think of it this way: if a personal loan includes debt consolidation, you could still be paying for a simple sushi dinner that you put on your credit card 6 months ago!
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Unsecured lines of credit
This is the best of the bad. While the rates are still higher than secured lines of credit (credit lines lent against equity in the home for example), they are generally the most affordable and flexible of the bad debt choices. Typical interest is based on prime, usually prime plus 1, 2 or 3%.
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JUST FOR TODAY
Take out your files for each of your debt accounts, and mark which debts are truly ugly and which debts are just plain-old bad.
Now for a bit of contemplative thought…
Take a few moments and think about the last time you bought/leased a car. By any chance were you focused on the monthly payment rather than the total borrowings? Have you ever leased so you could afford the payment? Vehicle purchases are often financially problematic. You must stay focused - not on the monthly payment of the loan - but on quick repayment terms, so you don’t get stuck trying to trade in a car that still has a loan on it.
A great rule of thumb is this: when you can’t afford a repayment plan of three years, you can’t really afford that car.
Take the original purchase price (everything in) and divide by 36 payments. Can you afford that payment?
Finally, don’t worry if you’ve got accounts that don’t fit into today’s definitions of ugly or bad debt. Just put those files aside for now. We’ll get to two other categories of debt in the coming days. (Hint: They’re much better!)
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