Helllo!~ Another week, another financial blog post. How has your week been? Mine has been going pretty well, and I am super stoked about today’s topic.
Did you know there are two types of debt? Now, I know if you’re reading this you think debt is most likely bad. That ALL debt is bad. Bad, bad, bad. But, what if I told you there is Good and Bad Debt? I mean… most debt is BAD, but there are some good guys too.
Today I want to focus in on those bad guys – the bad debt, and see what it is and how we can combat getting ourselves into it.
Defining Bad Debt
Bad debt, in the Personal Finance sense, is debt that has massive depreciating value or has an extremely high interest rate. A high interest rate I would consider as anything >6%, because that’s definitely worse than long term market gains. But, a mortgage isn’t bad debt and neither is a business loan (for the most part), so if an interest rate is >6% on either of those things, I would not consider them bad debt, except in extreme circumstances.
What is Bad Debt? – Common Examples
Credit Cards are the most common form of bad debt. Do you know the interest rate on your credit card? Most are >18%! This rate is significantly higher than most consumer loans. The payment schedules are also maximized so the debtor will owe as much money as possible. Any type of balance on a credit card is never a good idea.
Cars are the second form of bad debt. How many people do you know with $30,000/yr income or $60,000/yr income with cars that are $30,000 or more? Thousands of Americans fall into this trap of having a high car payment. While the interest rate on car loans is often low, transportation costs per month should be <10% of your income. This includes gas, maintenance, registration, and a car payment. Having a car payment you can’t afford on an asset that loses thousands of dollars in value within months is never a good idea.
Consumable Goods America, and many globalized cultures value spending money and the “consumer debt”. Have you ever gone into debt during the holidays, or spent more than you planned? This is consumer debt and most things bought have no or little resell value.
“Transportation costs per month should be <10% of your income. This includes gas, maintenance, registration, and a car payment.”
How to Avoid Bad Debt
If you’re familiar with personal finance or the Femillionaire mindset, you know exactly what I’m about to say. If not, that’s okay! Welcome to the club.
Step 1: HAVE AN EMERGENCY FUND. I cannot stress this enough. Seriously, you need to have savings set aside for when shit hits the fan- because it will, and usually it’s a lot of shit all at once. Just start. saving. now. Even if it’s only $15 a month, having a $100 emergency can compound into $200 very quickly when put on credit cards.
Step 2a: Be smart and have awareness of your financial situation, especially when buying a car! Buy a car that you can afford, has low monthly payments, will be paid off in 36 months, and that you can put a big, cash deposit down on. I know this is a lot and often means you won’t be buying a new car, but there are so many used cars that are only a couple of years old, have low miles and are incredibly reliable.
Step 2b: Buy a reliable car! Research which brand/years are most reliable. Generally, you can never go wrong with a a Honda Civic, Honda Accord, Hyundai Elantra, or Hyundai Sonata.
Step 3: Self Control. This is going to be one of the more challenging steps (if not the most challenging!). You can have an emergency fund and an affordable car, but still lack self control. If you don’t have self control, you’ll find yourself in a cycle of gaining bad debt, paying it off, and taking on more bad debt.
“You can have an emergency fund and an affordable car, but still lack self control.”
The Bottom Line
Bad Debt is, well, bad. It’s bad for your wallet and your mental state. Avoiding bad debt at all costs should be your primary goal. If you already have bad debt, paying it off before all other debt should be your priority.
Have you ever had bad debt and paid it off or are in the process of paying it off? I would love to hear your stories below!