Do some debts make sense?
There's "good debt" and "bad debt." These tips can help you tell the difference.
It's nearly impossible to go through life without incurring some debt, but owing money can be a double-edged sword. On the plus side, manageable debt can let you make larger purchases and establish a solid credit rating. But carrying too much debt and handling it poorly could keep you from saving — or undermine your entire financial foundation.
Learn how to identify smart purchases, avoid irresponsible spending and manage your money wisely with these tips:
Discern between good debt and bad debt.
"Good debt" typically is considered necessary and even beneficial. It's often incurred to purchase essential items you couldn't afford without draining your savings, such as a home improvement. Or it can pay for a potentially wealth-building asset, such as a college education.
"Bad debt" generally is money spent on unnecessary purchases that are out of your budget — or that you could afford without a loan. These might include revolving debt, high-interest loans and purchases with depreciating values.
"You don't want to take on debt that owns you," says Gail Cunningham, spokesperson for the National Foundation for Credit Counseling (NFCC). "Debt shouldn't prevent you from living your life, saving for retirement or investing money." If debt has become a burden, consider consolidating your bills.
Know how much debt is manageable.
When deciding whether to take on additional debt, look beyond the monthly payment. Calculate the total cost of the credit over time, Cunningham says. Also consider your income. The NFCC reports lenders recommend keeping personal debt below 36 percent of your gross monthly pay.
Besides running the numbers, review your budget to see if you can afford the debt without putting off other obligations or cutting back on saving — especially saving for retirement. "Time is money's best friend," Cunningham says. "The sooner you start saving, the better off you're going to be."
Understand the benefits of debt.
Debt actually can have upsides as long as you're using credit as a convenience and not a crutch, Cunningham says. "Credit isn't the problem," she says. "It's the irresponsible use of credit that creates the problem."
Your payment history and the amount of money you owe make up most of your credit score. Handling debt responsibly can boost your score, making you more appealing to lenders and allowing you to consider more financial opportunities. Not being able to pay off your debt could lower your credit rating, subject you to higher interest rates and possibly prevent you from securing credit at all.
To turn around a difficult debt situation, the National Foundation for Credit Counseling offers many tips, including reducing expenses wherever possible, making more than the minimum credit card payment and not hiding purchases from family members. Or plan to sit down and talk with a financial professional to discuss your options.
Crunch the numbers.
See when it can make sense to pay off a personal loan with the help of our calculator.