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Good Debt vs. Bad Debt

By | Debt

Good Debt vs Bad Debt

If you’ve been trying to improve your credit score, you probably already know that “debt” can be a scary word. As such, you’ve likely been trying to avoid it as much as possible. But according to many credit experts, not all debt carries the same weight when it comes to how it affects your credit score. In fact, some types of debt are considered good debt — or at least not likely to harm your credit score. Here’s a look at how certain types of debt may affect your credit rating.

What Separates Good Debt From Bad Debt?

The first thing you should know is that any type of debt that is considered an investment tends to be good debt. This means if you’re taking on debt to buy an item or service that will improve your net worth in the long run, it’s likely good debt. In short, common examples of good debt include mortgages, student loans, business loans or anything that will save you money in the future.

On the other hand, bad debt won’t make you wealthier or help you save money. Most people who rack up bad debt do this by using credit cards to buy items they want and then make minimum payments on those cards so the interest continually accumulates. Basically, if you’re just using credit cards or taking out loans to buy disposable items, you’re collecting bad debt and will likely lower your credit score.

Types of Good Debt

Mortgage Loans

One of the best types of debt to take on is a mortgage because houses usually increase in value over time, unlike most other items you might buy. You will likely recoup the costs of your house and then some when you sell it, so taking on a mortgage loan is considered a good investment for most people. And even though you pay interest on this type of loan, it’s far lower than most credit cards, and you can deduct it on your taxes.

Student Loans

If the career you have in mind requires a college degree, you shouldn’t be afraid to take out student loans to pay for it. Of course, getting free money in the form of scholarships and grants is even better, but it’s not realistic for everyone to pay their entire college tuition this way. This is why student loans don’t tend to have a negative effect on your credit score, as long as you pay them back according to your payment plan once you graduate.

Business Loans

If you have a solid plan for a business, you shouldn’t be afraid to apply for a business loan to cover your startup expenses, including equipment and advertising. After all, you stand to make it all back and also support yourself if you have a stable business. This is why business loans are considered good debt when it comes to your credit score.

Expenses That Will Save You Money

Some types of debt are good because they will save you money over time, even though they cost money right now. For example, buying solar panels for your home is often considered good debt, since this addition will save you money on utility bills and improve your home’s value. Another example of taking on good debt is when you refinance via a loan with a low interest rate so you can pay off a loan that has a high interest rate. This move could save you hundreds or even thousands of dollars, so it’s usually worth taking on more debt.

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Types of Bad Debt

Credit Cards

The No. 1 type of bad debt is the credit card. The average U.S. resident who carries a credit card balance has more than $5,000 in credit card debt, so it’s not uncommon to have this type of debt. But it can easily affect your credit score in a negative way, especially since you’re probably using credit cards to buy items that are depreciating rather than increasing in value. If you have credit cards and want to improve your credit score, you should stop using them and start paying more than the minimum, particularly on the card with the highest interest rate.

Payday Loans

If you’re low on money until you get paid, it may be tempting to get cash today by taking out a payday loan. But in the end, you’ll pay much more than you borrow because the fees and interest rate can be very high. In fact, the interest rate is often three times the amount you borrowed, making payday loans bad debt. If you need money fast, your best option is to borrow from a friend or family member who won’t charge much or any interest, and then work on building up your savings account to help you in times like this. That way, your credit score won’t suffer even when you have unexpected expenses.

Overall, if you’re going to have any debt on your credit report, it’s better to have good debt than bad debt. So if you’re trying to improve your credit score, you can start by focusing on paying off credit cards and any other high-interest debt. As long as you stay current on your good debt — such as your mortgage, business loans and student loans — your credit score should start improving.






Why Payday Loans are Worse than Credit Card Debt

By | Uncategorized

Many Americans look for “quick fixes” in the form of payday loans to tide them over to the next paycheck when faced with mounting debt and financial emergencies. Most people think a quick, short-term loan is a better answer than accumulating more debt on their credit card.  While your main goal should be to get out and stay out of debt, it is a much better choice carry debt on your credit card than get involved in a bad deal with a payday loan.

What separates payday loans from credit card debt? There are a few key items to note when considering your options.

  1. Interest Rates-Credit card companies do not hide the interest rate, which is usually between 12%-18%. Most payday lenders do not disclose the interest rate and, according to Consumer Union Reports, can be as high as 911% for a one-week loan; 456% for a two-week loan, 212% for a one-month loan.
  2. Time To Pay-Payday loans must be paid by your next paycheck or you risk paying high fines. Interest rates for short-term loans are compounded every week, leaving many customers thousands of dollars in debt. Credit card debt can be paid off over an indeterminate period of time.
  3. Full Disclosure-Credit card companies provide full disclosure to their potential customers, informing about annual fees, interest rates and grace period information. Most payday lenders offer little information regarding the loan, causing many customers to fall victim to their trap.

The future is uncertain for all of us. Taking a cash advance from a payday lender risks being further indebted to the lender if you are unable to pay it back on time (the words loan shark come to mind). It is easy to get caught in the cycle of borrowing more money to pay off previous loans, spiraling further and further into debt. The added stress of being threatened by lenders when debts are not paid only escalates the need for a hurried solution.

Astronomical interest rates are never a good idea. Work with your creditors and devise a plan that will help you decrease your debt and manage your finances. Time and patience will put you on the road to financial freedom. Avoid getting distracted by the lure of instant gratification and recognize that payday lenders are not the answer to your financial strife. If you need help getting your finances under control, contact Ovation for a free consultation.

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