What is Debt
Debt as defined by dictionary.com is:
something that is owed or that one is bound to pay to or perform for another
Essentially when you are taking on debt someone has agreed to give you something in return for something else to be paid at a later time. The lender agrees to take on a certain amount of risk and you agree to pay them a certain amount extra, interest, for them taking on that risk. The debts you owe can range from the .25 you owe your cube mate to the $250k you owe your mortgage company, hopefully your cube mate isn’t charging interest.
Types of debt
Personal loans are those loans you have made or have been made to you by family members or friends. These loans are typically loosley arranged and may or may not have defined interest terms or payback requirements. Seemingly this type of loan would be ideal but experience shows that loans to and from family and friends can put undo stress on relationships with dangerous side effects.
Hopefully you are, or will be, lucky enough to make it through school without taking out any loans, if not than you are going to fall into this boat. Student loans can be subsidized, where the government pays your interest while you are in school, or unsubsidized where it accrues until you start paying. Either way student loans aren’t necessarily a bad thing. You are financing your future, I don’t like paying it but I am glad I went to college.
The mack daddy of all debt. A mortgage is essentially a loan for a piece of property that is secured by the property. What this means is that if you dont’ pay back your debt, they take back their house. Typically mortgages have been seen as an investments which is “guaranteed” to increase in value. As we have all witnessed this couldn’t be further from the truth. Don’t buy a house for an investment unless it is really just an investment property.
Credit card, or plastic money, are little portable debt tallying machines. A credit card is a method for getting a short term loan for something you are going to purchase. You are given a plastic card, an exorbitantly high interest rate, and a spending limit. The credit card company hopes you do two things, 1.) max out the card and 2.) carry a balance. That way they continue to make money off of you. I like to have my card just because I have always had it, we use it for any large purchase but we never carry a balance on it we just collect the points.
These are the devil, no seriously they are the devil. I won’t even describe them here other than to say they make credit cards look like the saints of the debt world.
Good Debt vs. Bad Debt
Lets start with the fact that debt, no matter what kind, is still debt. You OWE soemone money and THEY have some type of leverage against you for it. In this sense all debt is bad debt, however, there is definitely debt that is OK and debt that is bad. The OK debts are things like your house which will eventually increase in value and your student loans which will eventually help you get a job. In some select cases it may even be OK debt if it is on a credit card, don’t tell Dave Ramsey I said that, it all depends on the WHY and the WHAT, not the WHERE.
Bad debt is debt associated with flipant spending for unnecessary items. Credit card debt is the biggest drain on the American household and yet so many people just can’t wait to swipe that AMEX or VISA for that new Coach bag, or the hottest new trend. These types of debts are typically referred to as consumer debts and should be avoided. If you can’t pay for it, don’t buy it just save your money and get it later.
This article is part of the Suburban Dollar Back to the Basics series. I plan to cover remedial personal finance topics which aren’t as sexy, or typically covered, in the personal finance blogosphere. My hope is for people to get a better understanding of basic personal finance without boring you to death, hopefully you will be able to share these posts with family and friends to get them into personal finance and have a good foundation of knowledge.