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Good Debt / Bad Debt: The Top Inappropriate Use of Credit

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.

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Part II: What does a credit score mean?

In “Part I: What does a credit score mean?” we took a look at the meaning of credit scores in being approved for a loan and in obtaining the best interest rates. “Part II: What does a credit score mean?” looks at: What a credit score means in your job hunt. What a credit score means for your...

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Part I: What does a credit score mean?

I spend a lot of time talking about the importance of building a good credit score, but a lot of people want to know: What does a credit score mean? In this blog post, I’m going to answer that question, taking a look at two factors: What does a credit score mean to a lender? What does...

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Should I Add a Consumer Statement to My Credit Report?

The Fair Credit Reporting Act allows a person to add a 100-word consumer statement to their credit report. Often, people use the consumer statement as a chance to explain a derogatory mark or a bad credit score. The consumer statement does not change a person’s credit score; it simply gives the consumer a voice. The statement,...

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Authorized Users—What Are They? How Can They Build Your Score Fast?

One of the first pieces of advice I give to people who have suffered severe financial crises and want to learn how to build credit is to become authorized users on credit cards. Authorized users are allowed to use credit cards but have no contractual obligation to pay the bills. For this reason, a person does...

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