4 Debts You Should Try to Avoid

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Excessive use of debt can be a major hindrance to your financial independence. Although sometimes unavoidable, here are four debts you should try to avoid as much as you can.

Credit Card Debt

Most of our debt problems come from the overuse or misuse of credit cards. Here are some interesting stats from the Federal Reserve’s latest Survey of Consumer Finances for 2007.

  • 46% of families have a credit card balance
  • the average value of credit card balances for families with holdings was $7,300

If you’re looking for resources to help get out of debt, check out these articles here.

Auto Loans

Yes, cars are a necessity for most people. We need them to get to work, take the kids to school, pick up groceries, and run other errands. Yet we tend to go overboard when it comes to car purchases.

It’s one thing to borrow money to purchase a car. In fact, I did this myself for the car I drive currently.

But the funny thing is that I actually had money saved up to pay off the balance in full. It wasn’t until the loan was almost paid off that I finally smartened up and paid the remaining balance in full.

The moral of this story is that I was paying interest to the car company, when I could’ve put that money in a savings account that would’ve paid me interest!

But borrowing money to lease a car that you use temporarily is a double-whammy. Not only do you get in debt, but you have nothing to show for it if you pay it off!

Some also get a new car and new loan as soon as the current one is paid off. In fact, before they actually need a new vehicle, they start wanting a new one. To respond, they do what it takes to purchase the new car, including getting a high-interest-rate loan that’ll take a long time to repay.

Instead of taking on an auto loan, how about learning how to buy your next car with cash?

401k Loans

Because there is a loan provision with the 401k, people may think there aren’t any consequences to doing so. However, here are some good reasons not to take out a loan.

Regardless of fault, if you leave your job before the loan is repaid, you then have only 60 days to pay off the loan. Otherwise, it’s considered a withdrawal, which will be taxed at your regular income tax rate. If you haven’t reached age 59 1/2, you’ll also have to pay a 10% penalty on top of that.

Not only do you need to repay this loan, but now the money is no longer invested in your account and working for you. You’ll lose out on additional interest, dividends, and capital gains.

And if you borrow from your 401k once, it may be too easy to justify borrowing from it again in the future. Thus, the habit of saving for the things you want and need will be lost. If at all possible, retirement money should not be touched until you retire.

Payday Loans

These short-term loans are used to cover someone’s expenses until their next payday. Payment is due in full at the borrower’s next paycheck, which is usually two weeks.

However, borrowing comes at a  heft price. The interest charges range from 15 to 30% for the two-week period. This may sound bad enough, but if you calculate the APR, the numbers come out to 390 to 780% interest!

So these are four debts to stay away from as much as you can. If you do this, your chances of reaching your financial goals will improve greatly.

Are you taking steps to get out of debt?

Photo by SqueakyMarmot

Comments

  1. Scott F says

    One more loan that should be avoided is the tax refund loan. In the USA, many (not all, thankfully), tax preparation companies will target the poor by telling them they will give them their refund the day they file. They don’t have to wait for the refund and get it right then and there. Problem is, the fee charged for this if computed out as an interest loan ends up being nearly 40% interest. If people will wait, they will have the full amount within a week, if they have a bank account and choose direct deposit. If they have to wait for a paper check, it will take longer but it costs them money they can’t afford to get it right now instead of wait.

  2. rbee says

    I am glad I married a discerning accountant she is great when it comes to our stewardship,great reminders from your post.

  3. says

    Hi Craig,
    These were 4 great areas to discuss. Interest can be a killer, especially with the auto loan, went through that ourselves. There is another resource I discovered recently from one of my mentors a book entitled, The 5-Minute Debt Solution by Chris Hendrickson.

    Great advice thanks for posting it!
    Joe

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