Category: Debt Management

I suppose you could live your entire life without going into debt, though modern middle-class society in the United States seems to be designed to require at least some debt. Even if young adults can complete their education without taking on student loan debt, just about all new homeowners need a mortgage in order to afford a house. In some cases, debt is just a cost of middle-class living.

Some debt products should just be avoided, however.

1. Payday loans.

To qualify for a payday loan, you would need to prove a history of income. This will provide you a short-term loan, with the balance and fee due within weeks. Those fees could be $15 to $30 for every $100 borrowed, which on a two-week loan could be considered a 390% interest rate. If you aren’t able to pay off the loan when it is due, you can renew it for an additional fee.

Most people who take out payday loans fall into a cycle of debt, renewing their loans or going back to the lender often. It’s rare that someone in a short-term financial fix borrows money at a high rate for a few weeks and pays the loan off in full.

2. Refund anticipation loans.

These were marketed heavily a few years ago, and now that we’re heading into tax season it’s likely we’ll see more ads. Refund anticipation loans are often offered by the same company you might use to help file your taxes. If your income tax return forms show that the government owes you money, for a fee, these companies will be willing to offer you your anticipated cash now.

You can adjust your tax withholding at your job to make sure you’re not due a large refund when you file your taxes. There are few good reasons to keep paying the government more than you need to every week or two when you receive your paycheck. The “forced savings” rationalization is not a good reason.

3. Gambling.

For the sake of your kneecaps, you don’t want to find yourself in debt to a bookie. Movie drama aside, gambling is always a losing endeavor in the long run. It can be an addiction, so seek help if gambling is controlling your life. One problem is sunk costs. Once you start losing, you want to make up for your losses, taking larger risks.

If you’re a stock trader relying on the margin for making purchases, you might as well be gambling.

4. Rent to own.

If you have young children in school beginning to learn to play a musical instrument, you are likely encouraged to rent the instrument from the store. The rental programs are generally designed to either buy the instrument after some time or return the instrument to the store when the student loses interest. This is the best rent-to-own scenario.

Once you start renting electronics and furniture, you will generally get a bad deal. It’s likely you’ll pay much more than the cost of the product by renting, and you will likely be charged a high rate of interest.

5. Debt used to finance a depreciating asset.

One rule of thumb dictates that debt should only be used to pay for an asset that increases in price. For that to make sense, the price of the asset should increase at a rate higher than the rate of interest on the debt. The only problem is that you can’t consistently predict whether the price of an asset will increase.

Cars, unless they are collectible items, would not qualify under this rule. I would argue that if you need a car to earn money, the benefits of its use might outweigh the cost of the loan. And even a reliable used car could cost more than someone on the first day of his first job might be able to afford.

A few years ago, I knew many people who thought that real estate prices could never go down, conveniently excusing the fact they had no equity in their house. Banks were eager to let them buy their houses with hardly any down payment. If they were forced to sell after their house values dropped 20%, they would be in financial distress. And worse, if they were no longer able to afford their mortgage, they might have to foreclose.

What other forms of debt should people avoid?

Do you know your credit score but are wondering what it means? We’re here to help you understand it. The data pulled from all of your financial histories is placed into five primary categories that make up your FICO score. These five factors are as follows: payment history, amounts owed, length of credit history, new credit, and types of credit used. Represented by the pie chart below, each factor is weighed differently – some are weighed more and some are weighed less. To find out which areas of your personal finances should be given more attention, review the easy-to-use chart below, and then read out tips for raising your score through these five factors.

What Makes Up a Credit Score?

Payment History

As the most weighed factor of your credit score, your payment history is a very important factor in determining your chances of qualifying for loans and mortgages. We all know that there is no way of going back and changing your past, but there are indeed ways of erasing your past mistakes. With 35% of your credit score is calculated from your payment history, it is important to make sure that you avoid missed payments and late payments. Contact our credit team to find out how you can get your bad items removed from your payment history.

Amount Owed

The next largest factor that determines your credit score is the amount that you owe to your creditors. This is calculated by the amount that you owe on all of your accounts, and how much credit is available to you on your revolving accounts. To easily determine where you stand in regard to the amount owed, you can calculate your credit-to-debt ratio. In this, you simply must divide the amount of debt on your credit card by the limit amount on your card, and then multiply by 100. For example, if you have $2,000 in debt on the card and the limit is $10,000, then your credit-to-debt ratio is 20%. Anything below 50% is an acceptable ratio.

Length of Credit History

The third factor of your credit score is particularly pertinent to young people. This number is calculated by how long your cards have been open. Basically, the longer your accounts are open, the better. In calculating your length of credit history, FICO takes the following factors into account: how long your collective credit accounts have been established, how long each credit account has been established, and how long it has been since you used each card. The best advice regarding your length of credit history is to keep all of your cards open for as long as possible.

New Credit

Making up 10% of the weight of your credit score, having new credit is an easy way to boost your score. If you have a steady source of income, then consider opening one or two new cards for charging small items. The credit reporting agencies will, however, penalize you for overdoing it and opening too many cards in a short period of time. In order to effectively build your credit by opening new credit cards, it is important to do so in moderation.

Types of Credit Used

Finally, the last factor of your credit score is the types of credit that you use. The types of credit considered in your FICO score are as follows: credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans. It is important to have a good mix of all of these different types of credit in order to boost your credit score. Diversity in your credit cards and accounts is essential to building a good credit score.

As if college weren’t hard enough, getting out of those hallowed halls may be the lesser of your worries. Once you leave the grounds you are faced with the challenge of finding a job – or starting a business – in your new career path. This is much easier said than done since most companies want experience and, unfortunately for you, most college training does not count toward that so-called “real-world experience”. It’s a problem because now that you’ve completed school you have something that is common among a majority of college students: debt.

You struggle to create a life for yourself, and the moment you are out the starting gate you’re confronted with immediate hardship. You’re most likely well aware of debt by now in this stage of the game, but credit cards and some utilities aren’t even a comparison to the possibility of several hundred thousand dollars in school loans. Without a job you certainly can’t repay it in a timely manner.

Though you may figure it can wait, your college debt is not going to disappear, so there is no good reason to postpone the process of repayment. It’s important to realize the critical nature of debt repayment. It’s also smart to be aware that many companies have added a policy to check potential employees’ credit records as part of their pre-hire considerations. So beginning to pay off that loan is in your best interest.

Student loans are typically deferred for at least six months upon graduation. This can, unfortunately, motivate the proliferation of “professional students” who are afraid to complete college, fearing the financial trap of their loans despite running up even more charges. Don’t continue in school simply to postpone the repayment of your college loans. Have you begun to pay it or rather, like most, looked at it then casually discard it into the “I’ll pay this later” pile? Granted, having no job means paying is hard if not impossible. However, a college debt, as well as your other loans or credits, impact your credit rating. So even if you can only pay $20, do so. It’s a start.

The simplest way to get to that debt is to develop a budget plan. Make a list of all your fixed bills like car loans, rent, personal loans, etc. and add to that list your variable debt like credit cards. Prioritize the list and compare it against any income you may have. For some bills, you can briefly postpone them or work with a creditor to lower payments over time or even ask them to temporarily stop charging you interest. Whatever money you have left should be allocated, at least partially, to your student loans.

Unfortunately, the time to pay the loan without hardship may be long past. If you’ve ignored your college debt for too long, claims can be filed against you. It would then be prudent to seek alternative methods of paying off your debts, such as a personal loan. The interest will tend to be lower and the bill will get paid.

You need to repay your debts – college included – as soon as you can. You should practice debt-free living at every step of your life. Think about simple things like extra clothing, trips, dining out, and movies – all of which can be scaled back, if not eliminated, to help repay your loans. Before purchasing such items, consider whether you really need them. If not, at least defer the expenses to later. Make the elimination of debt your higher priority.

Is it better to start an emergency fund or pay off your debt as quickly as possible? If you are anything like most human beings, you want a definitive push in one direction or the other. Most financial advisors and ten-year-old kids can tell you which is better to go with by simply looking at the numbers. However, like all things in life, it is not quite so simple. This is a great example of people thinking the world is in black and white.

Paying Off Debt Saves You Money

It does not take a genius to tell you that paying off your debt as quickly as possible is the best numerical choice to go with. You get one to two percent interest a year from a dollar in a savings fund while the dollar in debt collects fourteen percent interest a year. Each year you don’t pay that dollar off you are losing by twelve percent. The smart thing to do would be to pay off the dollar and start building an emergency fund now that you are out of debt in order to avoid possibly falling into debt again. That is the whole argument made by those that advise it is better to pay off your debt before creating an emergency fund.

Real Life Has Emergencies

Unfortunately, most of us cannot start from scratch with nothing saved without ending up in debt again. It is an unpleasant fact that things go wrong. The emergency fund side of the issue is a bit more realistic. Basically, you want an emergency fund set up so that you can avoid going into more debt than you have already gotten into. The idea is that, even though the debt you currently have is creating interest and destroying your credit, you aren’t adding new debt on top of the old debt. This raises a good point. Using all your money to pay off debt only to end up penniless will lead you back into debt the second an unexpected expense puts a vice grip on your finances.

Finding Balance

So then, which should be top priority? Neither. One extreme or the other will only condemn you in this situation. If you ignore credit debt, it will be 20 years before it’s paid. Ignore emergencies and you may go into bankruptcy. That is why you have to take the eclectic approach and do a little of everything. Save money in an emergency fund in order to keep from ending up with new debt, but also pay as much of the debt you already have accumulated as quickly as possible. At the very least, keep yourself from being late on credit payments, amassing more expense.

Here’s how to calculate how much needs to go into your emergency fund to make sure your credit card doesn’t end up costing you more than it needs to. Unfortunately, this has to assume nothing else major goes wrong, like a job loss or the total loss of your uninsured car. (Hint – make sure your car insurance is paid!) In the beginning, there are only so many emergencies for which you can prepare.

Pay a Little Extra on Credit, Build Your Emergency Fund

So, you need to have enough money in your emergency account for the necessities for one month. That means gasoline to get to work, the bare minimum amount you need to get by for food, the monthly payment for your car insurance, and the total minimum payment on all of your credit cards. Most utility bills will let you slide for one month without a large penalty, so if there’s something that has to wait, let it be those…but no more than 30 days. Once you have this amount, you can first focus on getting that amount saved in your emergency fund while paying the minimum plus at least $10 extra on one of your credit cards.

Attack Your Debt Full Force Only After Emergencies Are Covered

Once you have your emergency fund covering the necessities, start throwing everything you’ve got at your credit cards. You can attack the biggest first or not, depending on which method motivates you best. You’ll save more money by paying high interest cards with bigger balances first, but some people need to see one card paid off quickly to feel like they are progressing. Those folks may be better off with snowflaking, or paying of the smallest debt first.

This simple solution will solve your debt issues in a slow yet manageable fashion that, honestly, will take longer than paying credit first, at least in a perfect world. In the real world, this might be faster. You will end up debt free, with a nice cushion should anything unexpected arise.