Debt can be a slippery slope. Some types (like mortgages) are healthy and improve your ability to do and buy the good things in life. Others (like, um, the sofa you’re still paying off) should come with a “danger” warning before you sign on the dotted line. Here are four types of debt that can be catastrophic if you are not careful.
1. Credit card debt
According to Value Penguin, the average credit card debt for families with a balance is $ 9,333. Even more astonishing is the fact that the average credit card interest rate for existing customers is 14.58 percent. (It’s 17.98 percent for new offers.) Here’s the crux of the matter: credit card debt makes it almost impossible to build up wealth, because no matter how much you pay off each month, if you don’t fully cover your balance, the interest charges alone are enough to cut every progress in half.
Yes, there is the attraction of developing strategies around points and cashback. But the moment you start balancing, any potential for financial gain is lost. (Check out the section of your bank statement each month to get a feel for how your interest payments add up, especially if you’re only making the minimum payment.)
2. Payday Loans
When you are living from paycheck to paycheck, payday loans can seem attractive because you are essentially getting cash instantly. But this type of loan is another form of debt that can get you in hot water quickly.
For one thing, you should read the fine print. A high interest rate is charged on the day the payment is due, and if you fail to meet this deadline, the interest rate will go up … and go up. In fact, the average payday loan pays anywhere from 10 to 30 percent for every $ 100 they lend you … and only if you pay them back on time, according to Dave Ramsey.com. In addition, payday loans are not something that you can escape or easily bump down the road. In most cases, when you complete an account, you give the lender direct access to your checking account, which means they’ll get the money back whether you can afford it or not.
An alternative if you are short of money? Consider setting up a credit circle with friends in which each participant contributes a certain amount of money each month, with the “pot” going to one person in turn to help the party most in need. (There are even websites out there that can help you automate it to build better credit.) However, you could also turn to a credit union for an “alternative payday loan” that comes with above-average interest rates, but comes with it bad credit and usually has a more flexible repayment schedule. Another option: negotiate with the person you owe money to. COVID created a global crisis that has put pressure on institutions – think doctor’s offices, banks, whoever has issued your car loan – to be a little more flexible. Conclusion: asking never hurts.
3. Hire purchase plans
A rent-to-own plan is an arrangement that allows you to pay for something – usually consumer goods, but also real estate – in installments with the option to purchase it later. But as tempting as it is to leave a business with something you can’t afford (like the washing machine you had to have), it really isn’t a sensible financial move and could cost you more in the long run. Lease-to-purchase contracts often require you to pay monthly installments that are more than the cost of the item when prepaid in full. Also, there are typically high late payment fees, no protection or financial assistance with repairs, and a number of hidden or additional costs that you may not notice right away.
Better bet Stick to items within your budget. Or buy second hand – there is so much cute stuff out there and it’s better for the environment.
4. Personal loans
Before considering a personal loan, you should consider why you would want to get a loan. When you are getting out of a mountain of credit card debt and want to pool your cards into one lower monthly payment, this type of loan can be beneficial. But if you’re doing it to pay for something you currently can’t afford – like a new TV or the cost of a wedding location – think again. The interest rates may not be as high as a credit card, but they’re not far from it. (Also be careful if you have poor credit – interest rates tend to be higher based on your score.) Worse, personal loans come with processing fees and a non-negotiable fixed monthly payment. Missing or falling short on a cycle can include a lawsuit. It’s not worth it.
TIED TOGETHER: Avalanche, landslide, or snowball: which is the best method to pay off your credit card debt?