Is all debt bad?
Obviously, a pretty important part of being financially secure is keeping a lid on debt.
I see so many finance professionals advocating going completely debt-free. Should we?
Well, the answer will surprise you.
It’s just not that simple.
Is all Debt Bad? It’s not even all the same!
There are two kinds of debt:
- Installments
- Revolving
Installments
Installments are what most people think of when they think of debt.
Car loans, mortgages, hospital bills, and any kind of debt where you are working toward a zero balance are installments.
This kind of debt is literally a black hole for money. And even worse, interest usually makes you pay 2-3x more than what the product is worth.
I will give you an example. When we moved into our new home, the fridge did not work. Frustrating. We went to Rent-A-Center just to see what they wanted for one.
They wanted $1000 same as cash for a model that costs $500 at a big box store. And then if we couldn’t pay it off in 6 months, that price jumped to a whopping $1800! More than 3x the price at Lowe’s or Home Depot for the same model.
Needless to say, we went without a fridge for a while until we found an affordable one on Facebook Marketplace. Fortunately, we ended up paying a only $100 for an older model that still works great.
Installments are the debt you want to avoid!
Revolving Debt
Revolving debt is any debt that you pay down or off, and the credit line is still available to you. So basically, credit cards.
Credit cards are demonized because of their outrageous interest rates. Seriously, 18-25% or more, sometimes more per month.
And for a long time, that scared me away from them.
But the problem with avoiding credit cards is that your credit score will suffer incredibly without them.
The absence of revolving debt kept us from buying a home on a mortgage.
This was a very personal decision because we were under a lease with an abusive landlord and needed out.
The only way out was by buying a home using the landlord as a realtor. We fought with the landlord over feces and bedbug-infested carpet and repairs that never got made. Some trash from the previous tenants stayed in our yard for weeks until WE hauled it to the dump.
Arkansas has no laws that protect tenants’ rights. And we suffered for it. So we decided to take on the installment debt.
However, even though we had decent credit, no bank or lender would lend to us because we had no revolving debt. We were told several times to get a credit card and come back in 2-3 months. So we did.
We quickly got a mortgage, a GRANT for our down payment and closing costs. The only payment due at closing was our first insurance payment.
Revolving Debt and Your Credit Score
Even if you never plan to pursue debt again, like getting a car loan or mortgage, you still can’t ignore your credit score!
Your credit score can keep you from getting jobs, affect insurance premiums, deposits on utilities and cell phone contracts, and much more.
A good credit score assures potential employers or companies that you are fiscally responsible and live within your means. But, of course, this makes you a very tempting customer!
Beating the System
So if you want a good credit score and don’t want debt, what can you do?
So if you want a good credit score and don’t want debt, what can you do?
The answer is really quite simple:
- Get a credit card with a LOW credit limit
- Spend only ⅓ or less of your limit each month
- Pay it off at the end of each month
This ensures that you get the maximum benefits of revolving credit but rack up no debt.
Step number 2 is the most crucial step in this process.
Creditors use a calculation called Utilization Rate to represent fiscal responsibility. This is calculated as what your balance is divided by your credit line.
So, for example, if you get a credit card with a limit of $300 and only use $30 each month, your utilization rate is 10%. Low utilization rates drive your credit score up like a rocket blasting off!
You need to know more about credit and credit cards! Leave any questions you have below!
