You might think “debt” is a bad word in the language of personal finance. But debt is like fire; it can be a powerful tool for achieving our objectives, or a destructive force that can burn down both the present and future. Let’s talk about good debt and bad debt.
Good debt is borrowing that enables you to acquire an asset. A mortgage is the best example from personal life. A well-thought-out student loan can also be good debt. A business loan is good professional debt. By taking on these loans you are able to invest in something (house, business) that will appreciate in value and/or generate revenue. Of course, excessive good debt is actually bad debt, as many Americans learned when they took on too-big mortgages during the housing bubble.
Bad debt is borrowing used to fund spending that you could not otherwise afford. Credit cards and car loans are prime examples of bad debt. Racking up this sort of debt can limit your options both present and future by soaking up money that could be used to pay for current needs, or saved for goals like a house or retirement.
If you have amassed considerable credit card and other bad debt, you should prioritize eliminating it as soon as possible.
- Focus on debt-free. Identify your free cash flow (monthly income – monthly expenses) and put 80% of that money towards paying off your debt. Do this automatically by setting up auto-payments to your creditors, or by arranging to sweep money into a dedicated debt-pay-off account that you empty every month ONLY to pay debts.
- Negotiate for lower credit card pay-offs. Consider hiring a debt settlement company to work a deal with your creditors. There are many effective reliable firms out there, but also some not-so-reputable operators, so do your research.
- Consider refinancing your home. If you have equity in your house, a home equity line of credit might be a good option to pay-off your bad debt. While you still owe the same amount, the interest rate will likely be much lower, and you have just one payment to make, instead of several.