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MAKING MONEY WORK
There can be good debt as well as bad debt. Good debt
can be described as debt that helps you build equity
or increase your net worth. For example, education
loans usually are considered good debt because in the
long run more education generally translates into
higher earning power. Most people borrow money for a
mortgage to get a home—if the home purchase was a
wise investment that increases in value and adds to
your net worth, then it would be considered good debt.
Another example of good debt might be loans to run a
small business—for example, if you borrow money at 7
percent and use that money to make a 15 percent or 20
percent return, then it would be considered good debt
because you are using the loan to increase your net
worth. Good debt includes loans that help to build
your financial future.
On the other hand, bad debts are the ones that
negatively impact your financial future. Bad debt
might be described as obligations that last longer
than the purchase item and ones that have no return
toward increasing your net worth. Before making a
purchase via a loan, ask yourself is this good debt or
bad debt—will the debt help to increase my net worth
or will it decrease my net worth? Avoid as much bad
debt as possible. The Financial Planning Association
suggests that total debt should not exceed 10–15
percent of your take-home pay—excluding mortgages.
Many credit experts recommend that debt should not
exceed 25 percent of disposable income. Over
indebtedness can push you to the maximum to repay your
debt while still trying to maintain daily living
expenses. A sudden unexpected event such as a job
downsizing, divorce, a death in the family, an
uninsured accident, theft, a large tax bill, or a
major medical expense can have tragic results to your
finances and result in a credit crisis. A major
unexpected event combined with insufficient savings
and insurance can easily result in a credit crisis.
Assuming credit loans is something you want to avoid
if at all possible. Few things are worth borrowing
for. Avoid going into debt for rewards such as
vacations or fancy restaurant meals; save for them and
pay cash. Borrow as little money as possible and at
the lowest interest rate possible.
Most debt can be avoided if you take action to live
within your income. Consumer Credit Counseling
Services stated that the number one cause of money
problems with their nationwide clients was poor money
management including impulsive spending. Practice
delayed gratification—earn the money before you
spend it. Save for purchases if at all possible until
you can pay cash or use debit cards for them. When you
borrow money, you pay interest plus the principal
borrowed, so items purchased end up costing you much
more than the original price. Practicing delayed
gratification until you can pay cash saves you the
added cost of the item and has less negative impact on
your future net worth. Studies indicate that consumers
generally spend about 25 percent less when they pay
cash for items. This is due to the savings on interest
charges and the fact that you waste less money on
impulse purchases due to the temptation and
convenience of credit cards. Many impulse purchases
are for items you do not even need.
Forty percent of people pay off credit card purchases
in full every month—the other 60 percent would
benefit from making changes in their spending habits.
If you purchase only what you can pay cash for,
chances are you are in control of your financial life.
You may be overextended if you cannot pay all of your
debt—excluding mortgage—in 18 to 24 months. If you
pay only the minimum amount due on your outstanding
credit cards month after month, you might stay in debt
indefinitely since most of the payment goes toward
interest. You definitely have a credit problem if you
cannot pay all of your monthly minimums. You should
eliminate nonproductive, expensive debts as soon as
possible.
Learning to manage your debts will make a
different to your financial future.
By Bill G. Page
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