Much has been said about the good debt versus bad debt, and the latest report from the Federal Reserve speaks volumes into how often people are misusing credit. According to the report, Americans owed a whopping $2,418 billion in debt in June.
With this much debt riding on their shoulders, how can Americans earn a great credit score? Worse yet, how can we be expected to invest in our futures if we have a huge amount of debt to carry?
By learning to distinguish good debt from bad debt, Americans can turn their bad credit into good credit, and make wise investments in their future.
Over the next seven weeks, I will take a look at three of the top inappropriate uses of credit, as well as the four questions a person must ask to determine whether something is good debt or bad debt.
Good Debt / Bad Debt, Inappropriate Use of Credit #1: Using Debt to Finance Debt
The first rule of carrying good debt instead of bad debt is this: Unless you have a budget that proves a loan or credit card will indeed help solve your financial despairs, never take out a loan to dig yourself out of debt.
Using a loan to solve a financial problem can be a smart move, if you have the budget to prove it. But if you are just reacting to your financial stress by applying for more loans and credit cards, you are carrying bad debt. In fact, if you cannot prove that the loan will improve your financial situation, getting a loan to pay debt is the single worst use of debt out there.
How will the loan help you dig yourself out of debt? When will you break even? What do the numbers prove? How will this loan reduce your overall debt? Unless you can answer these questions, never apply for a loan as a method of solving financial problems.
Using a business loan to increase cash flow is wise. Another example of good debt would be applying for a lower-interest loan to consolidate your credit card debt.
But you must run the numbers, or you risk complicating your financial situation. Without proof that the loan or credit card solves your financial problems, you are simply postponing a financial breakdown, which will be far worse if you add more debt. Always base your financial decisions on substance rather than on emotions. If you are scared for your future and take out a loan as a reaction to this fear, but you have no idea how this loan will provide a permanent solution, you are taking on bad debt. Why bother? The loan is nothing but a band-aid that will eventually fall off to expose wound that has been made deeper.
There’s no two ways around it: If you are in debt, you need to either make more money or spend less money. Building more debt to dig yourself out of debt? In the good debt / bad debt debate, this one is a no-brainer!
Be sure to join us next week for the second part of the good debt / bad debt series. And while you are at it, learn how to improve your credit score by attending our free teleseminar.
