We’ve all been there. You finally got that raise that your boss has been promising you for the last two years. You’re so ecstatic you round up your friends and family and pop some bubbly to celebrate this momentous occasion. Then bam! You get a letter in the mail letting you know that your rent is going to go up next month by 10%. You think to yourself, it could be worse, at least the timing is right and you’re getting that raise.
However, later that month your car starts to overheat on the freeway. Great luck, right? Just when you thought things were finally looking up. After taking it to the auto shop, you find out it’s going to be quite the expense to fix. You would of had enough to cover everything had your rent not gone up. But you’re in luck, you just received this new Credit Card in the mail with great rewards to help with this unexpected burden.
This is how it is for most Americans — one thing after another and the means to keep up is often out of reach as prices rise due to inflation and income remains relatively static. As the cost of living continues to rise every year, it becomes a burden on many families across America to simply pay their bills and stay afloat. Topple on unexpected life events such as medical bills, car/home repairs or unemployment, and you might just feel like it’s impossible.
It’s not all grim though, the majority of America –especially in high cost living areas– rely on credit cards to bridge the gap. Most of us rely on credit to pay for things in advance so that we can live a more comfortable life. In fact, many of us were able to obtain an education by relying on credit from loans, plus interest, that we have yet to pay back.
Having debt often comes with a stigma, but the truth is, most of us have debt, including our very own country! Debt doesn’t have to be a bad thing. You just have to know what debt is — the good and the bad — and how to use it to your benefit rather than to your demise. So, let’s start with the basics.
What Is Debt?
To put it simply, debt is money that was borrowed from a lender and must be paid back to that lender at a specified date in the future. It’s important to note that debt can either be secured or unsecured. Secured debt occurs when an asset, such as your home, is used as collateral. Whereas unsecured debt is not backed with collateral and, in the event of default, requires a lawsuit to collect the remaining balance of the loan. The kinds of debt covered in this article are of the unsecured variety, and can even be beneficial in helping you to set yourself up for a brighter future.
Since a dollar today is worth more than a dollar at some point in the future (this concept is called the “time value of money”), the lender must be compensated for giving up the possibility of saving or investing that dollar today. This compensation comes in the form of interest payments, which are added to the principal of your debt to make up the total debt burden. That is, you are paying someone else to use their money.
Let’s look at a simple example to see how interest rates work. Imagine you take on a loan worth $5,000 with a 10% APR (annual percentage rate) that you plan to pay back in one year. One year later, you will have to have paid back 10% more than the initial $5,000 principle, totaling $5,500.
What Is APR?
APR is the interest rate you’ll usually see on credit card statements. As the name suggests, APR represents the interest rate you will pay on an annualized basis, making it a convenient metric for comparing credit cards. Banks will usually charge interest on a shorter basis, such as monthly or quarterly, and so APR does not convey the effects of compounding interest.
Different Kinds of APR
APR is applied on either a fixed or variable basis. Fixed APR applies a guaranteed interest rate for the duration of the loan, so you know in advance exactly what you will have to pay in interest relative to the balance of the loan. A variable APR, however, may change according to the terms and conditions, so pay careful attention to the fine print in such cases.
There are also different kinds of APR depending on what it is applied on. The most general is called “purchase APR,” which is the rate that is applied on any purchase made with the credit card. If you need to borrow from your credit card, you should check the “cash advance APR.” If you miss a payment or otherwise violate the terms of the card, you will face the higher “penalty APR.” Finally, you may encounter an “introductory APR” offer that applies a low APR for a limited duration, usually for the purpose of balance transfers or cash advances.
Common Types of Debt
Consumer debt refers to any debt held by a person or family. It is typically used to finance common expenditures that enhance one’s standard of living, such as mortgages or auto loans.
Consumer debt can occur virtually any time a lender agrees to loan something of value to a borrower under the promise to pay the borrowed sum back later with interest. However, a few types of consumer debt are far more common than others. These are credit card, medical, and student loan debts.
Credit Card Debt
Credit card debt is the most common kind of unsecured consumer debt. The population of the United States is around 330 million, and according to creditcards.com, there were 360 million credit cards in America, as of 2017. Based on this information, it’s very likely that you have a credit card in your wallet– if not more than a few. If you have a credit card or are thinking of obtaining a credit card, it’s important to choose one that’s right for you based on your usage. Some offer better APR terms for services such as balance transfers, lower interest, rewards, cash back, etc. A few great resources to compare the best credit cards for your specific needs are Nerd Wallet and The Points Guy.
Medical debt results from huge hospital or treatment expenses that the patient cannot afford to pay, either through lack of insurance or a gap of coverage. Medical debt is largely an American phenomenon, as high hospital charges can bankrupt the underinsured in need of serious treatment.
Student Loan Debt
Individuals who wish to pursue a post-secondary education, such as college or grad school, yet lack the means to pay will have to turn to the student loan market.
At the moment, student loans are usually sponsored by the federal government, with schools and other, private institutions occasionally providing loans as well. Student loan debt can become especially burdensome if you find yourself with limited capacity to pay it off. Unlike other forms of debt, it cannot be eliminated through the bankruptcy process. There is also no statute of limitations for student loans, which means that the right of debt collection on behalf of the federal government will never expire.
Good Debt vs. Bad Debt
As mentioned, contrary to what many believe, not all debt should be considered bad when used as a tool in your personal finance plans. In general, debt can be considered “good” when it has positive value to you now or in the future. That may still sound vague, so let’s explore the idea with an example.
As mentioned before, student loan debt can be risky to take on if you don’t have the means to pay it back over time. However, that doesn’t mean it’s bad in all cases. Since a college education helps one to get a better job and earn a higher salary, a student who takes out loans but manages to earn a high enough salary to pay them off has benefited from the investment in his or her human capital. Imagine now, however, that another student also takes out a loan but ends up dropping out of college before graduation. This student loan has become bad debt, as the student is little better off without the degree than if they had not gone to college and taken the loan in the first place. The loan is now unproductive and simply serves as a drain on financial resources. The same holds true, albeit to a lesser extent, if the student does graduate but in a field with little demand and low pay.
Essentially, debt that adds value or income now or in the future can be considered “good” debt. However, deviations from or failures of plans that required that financing can quickly turn a “good” debt into a “bad” debt. This is true of credit card debt as well. Credit Cards can have a positive affect on your overall financial landscape. Though, it’s important to do your due diligence in finding the best credit card for your situation, while also having a solid budget and pay off plan that can helps to mitigate the risks of bad debt.
This is alot to take in, but there are resources to help successfully navigate your financial future. Money Ladder has a team of Certified Debt Advisors who are well versed and skilled in all areas concerning debt and further can help those that are $7,500 or more in unsecured debt.
They have over 12 years of experience in helping people to get out of debt and to find ways to use debt to their advantages. Remember, not all debt is bad — and Money Ladder can help you to define the good from the bad debt towards financial freedom.
You can call Money Ladder to speak directly to to an advisor at 1-888-585-8492 or click below.
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