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Good debt vs. bad debt

How to identify the good and tackle the bad

 

Not all of the balances you carry will drag down your financial future. Despite the bad rap debt often gets – and it’s mostly deserved — there are certain types that shouldn’t keep you up at night. Before you take on more debt, though, it’s important to understand the differences between the good kind of debt and the kind that can lead to stress, sleep deprivation, and worse.

Think about it like this: Good debt often takes you where you want to go in life. A home loan secured at a relatively low-interest rate offers you a place to live while building equity. The interest on a mortgage is also tax deductible. A vehicle loan provides you with reliable transportation and a student loan assists in funding education so your future self can earn more. Good debt is often an investment that pays returns.

On the other end of the spectrum is the not-so-great kind of debt so many Americans owe on credit cards, revolving accounts, and personal loans that can potentially drain checking accounts and even wipe out someone’s savings if they aren’t careful.

What makes some credit card debt so bad? If you are able to pay your bills on time every time and don’t carry a balance, then credit cards can be useful tools to pay for purchases. If you find yourself unable to pay off the entire balance at the end of the billing statement or have trouble paying the minimum each month, that’s where the trouble comes in. You need only to flip over your most recent credit card statement, if you still get the paper kind, to learn about how your balance is calculated – it’s typically daily – and how much a late charge will cost: Up to $40 on some cards. Such penalties add up fast. You can find yourself owing as much in interest and late fees as you do on the original balance.

Here are some proven strategies for digging yourself out of the bad kind of debt:

Tackle high-interest balances first

One way to pay off debt is the avalanche method. First, get out a notebook or open a word document on your computer and list out all of your debts in order of the highest interest rate to the lowest. Then, figure out how much you can scrape together to pay down all of the combined debts each month. After making the minimum payments on all of your credit card balances, use what’s left over to lower the debt of the highest interest rate card. Once you have paid that debt off, move to the debt with the next highest interest rate and repeat the steps. Be patient. This could take months or years. But because you are paying off the highest interest rate debt first, this is the quickest (and cheapest) path to becoming debt free.

Consider a balance transfer

If you qualify, transferring a balance to a card with a zero or low interest rate for the first year or 18 months could be another way to pay down debt while pausing those high-interest charges. If you are able to transfer a balance, make sure to set a reminder for yourself to make timely payments. Missing the due date by just one day can promptly end the interest-free period and add on late fees to your balance.

Pick up the phone

With inflation spiraling, the interest you pay on your credit card balances is likely to keep moving on up in the near future. You can try to get ahead of this a bit by calling your credit card issuer to see if you qualify for a lower interest rate. Be sure to ask nicely. And remember, the answer is always no if you don’t ask.

Written by Jean Chatzky, with reporting by Casandra Andrews. Aug, 1 2022