How to Decide Which Type of Debt is Worth It

Today’s great post is from Trisha. You can follower her on twitter @thatdangvegan or check out her blog thatdangvegan.com.

(Also – our Podcast hit 100K downloads this week, so a quick thank you!)

How to Decide Which Type of Debt is Worth It

Debt. What a nasty sounding word. Most of us shudder at the thought. Well, I’m here to tell you that having debt is not always a bad thing. Some people will tell you to stay away from loans at any cost, but to the contrary some loans can actually improve your financial situation years from now. Student loans, credit cards, home loans, and auto loans are all a part of financially smart debt. But how do I know when it’s the right time to go into debt?

How to Make the Decision:

Why Do I Need It?

It’s important to treat yourself now and again. I want to make it clear that purchasing small things here and there just for the heck of it isn’t a bad thing. However, if you’re thinking about getting a credit card just so you can purchase some new furniture, with no way to pay it off, it’s probably not the best idea for your financial future.

Will It Benefit Me Years From Now?

I prefer to think of loans in the terms of investments. Do I want to invest in a coffee table? Nope. I’d rather buy that outright. Although, I would like to invest in my education or a home. These things will benefit my life immensely in the long run. Investing in my education might earn me an extra million dollars over my lifetime. Investing in a house could mean a hefty nest egg in my bank account. Homes usually increase in value over the years and every cent that I put into a home eventually will come back to me when I decide to sell. Those are two examples of loans that will benefit me years down the line.

Is the Payment Manageable?

Here’s the deal, you can really mess up your credit by accepting a new loan that you may or may not be able to pay off monthly. If you aren’t 100% sure that you can make the allotted payments, then definitely don’t do it. Yes, it is possible to bring your credit score to life back once it has reached the pit of despair, but it’s a lot more difficult to build it up than it is to bring it down.

Why is this a big deal? If you trash your credit score now, you could be trapped later in life when you really need that credit score to shine. The key is to start with small, manageable loans that you can work with right now. Then, as long as you’ve kept up on the payments, you’ll have a sparkling credit score when you go to make a bigger purchase like a home or a car. A better credit score means that the bank will trust you with more money. This could be the difference between a fixer-upper home and the home of your dreams – depending on your credit habits when you were younger.

Common Types of Debt & How (if) They Are Useful:

Credit Cards – (for why Distilled Dollar doesn’t recommend CC’s, click here)

Yes, credit cards can be helpful to your credit, but personally, I would only suggest this type of debt to someone who has enough money in the bank to pay of the entirety of their credit card. A maxed out credit card just sitting around collecting dust isn’t doing anyone any good (I know from experience). Remember, things that positively improve your credit are items that can be paid off entirely in a timely fashion or you can at least make the base payment monthly.

In addition, interest rates are known to be astronomical on credit cards, especially those targeted at younger folk. This means, the large piece of what you’re paying for is just free money for the bank. Everything that you charge will be paid back in full and then some. For example, if a new TV costs you $600 you wouldn’t give the store another $200 just because they sold it to you. For these reasons, I tend to believe that credit cards cause more harm than good. They are easy to abuse, lose track of, and ultimately they can quickly ruin all the hard work it takes to maintain a decent credit score.

However, if you want something low risk, like a credit card, that will help you build your credit you can look into other types of credit cards that exists just for this purpose – such as a secured credit card. This is a card, which uses your own money instead of a loan to build your credit over time.

Car Loans

Car loans can be tricky. As you may or may not know, a lot of negotiating can take place within the purchase of a car. Unlike home loans, credit cards, or student loans, certain aspects of a car loan are much more flexible than other types of loans. With that in mind, before leasing a car, there are several things to consider.

First, choose who you want to lease through. If you lease directly through a bank you are likely to get a lower interest rate – especially if it’s the bank you currently are a member of. Often times, dealerships will offer no money down and no payments for a certain amount of time, which sounds wonderful. However, you have to take a look at the fine print. They might be charging you an arm and a leg in interest by the time your car is paid off. Is it worth that much more per month and in the entirety of your loan? You could end up spending thousands more than your car is actually worth. This means, when you go to sell the car you won’t be getting the total cost out of it that you put into it. This isn’t uncommon for leased cars because every car depreciates in value over time. However, you shouldn’t be losing thousands that you can never get back.

Next, take into consideration how long you plan on having your car. If you’re just going to lease another car right after you pay off this one, you might be throwing money right down the drain. Since the car is yours, you’ll have to pay for regular maintenance and repairs (when necessary) on top of your monthly lease price. The end goal should be to pick a reliable car that will last you years after the loan is paid off.

Finally, you should be willing to negotiate on price. Some dealerships are aggressive on pricing and will tell you right out of the gate that they won’t lower their price. This means that you will need to do some research. Find out what your car should really be worth versus what they are asking for it. Do a thorough check of the car to make sure you’re paying for a high quality item and remember to factor in the cost of interest. Going into the deal with all of the facts is the best way to avoid overpaying.

Home Loans

While some people are able to purchase a home, make some renovations, and flip it within a few years, most people cannot. If you’re looking for a stable place to call home for years to come with a low monthly payment, a home might just be the right thing for you.

The first thing I suggest, is finding a realtor that you trust. You don’t always have to go through a realtor, but in my opinion it will save you a lot of stress in the long run. A realtor’s job is to find you a home within your parameters that will make you happy for years to come. A good realtor won’t try to get you to sign on something that doesn’t fit within those guidelines. They won’t rest until you’ve found the perfect one.

After that, you’ll need to be prepared to spend a good chunk of money up front. You’ll need to pay for inspections, fees, money down, and possibly closing costs. Some of these costs might be covered by the sellers of the home, but sometimes they aren’t every situation is vastly different depending on where you live and the condition of the home. As such, I suggest you talk to your realtor about what areas are best for buying. They will know which areas have the lowest interest rates, which ones might ask for no money down, or which ones will even offer a first time homebuyers credit. These are all things you should know before you ever put an offer on a home.

Once you know all of that, I suggest getting pre-approved through your bank. This takes a lot of stress out of the equation later. Your bank will tell you how much money you’re able to spend, what type of monthly payment you’re looking at, and how long your mortgage is set for (could be 20, 30, or even 40 years). I wouldn’t recommend checking out a house if you aren’t prepared to live there for at least 5 years. Many realtors say this simply for the fact that you might not even really be making payments on your loan yet. After the fees, closing costs, and money down that we discussed earlier, you’re basically trying to make your money back. So be prepared to work on it for a while before you realistically have the leverage to sell your house and come out on top. After you have that information you’ll be able to truly decide if your loan looks manageable 5, 10, or 15 years down the line. If you don’t see yourself forking up that kind of cash a few years from now, it’s probably a good idea to stick with renting for the time being.

Student Loans

I tend to be biased when it comes to student loans. This is the one type of loan that can and will benefit you for the rest of your life. Even if you don’t end up getting a job in the same field that you earned a degree from, it will allow you more options when job searching. Degree earners are proven to be paid more throughout their time in the workforce. Not to mention, there are quite a lot of options when it comes to paying them back. Let’s start from the top.

Undoubtedly, student loans can cost you a pretty penny when all is said and done. However, you have some options if you don’t want to rack up a $150,000 price tag. The first thing you can do is choose to get your education locally. Choosing a local college costs significantly less than out of state education. It could be the difference between $5,000 per year and $30,000 per year.

If you’re still not convinced that you’ll be able to pay back the in state costs, check out local community colleges. Many of these cost even less than state universities and provide the same caliber of education. If you’re set on getting your degree from an accredited university, you can always look into transferring your credits over before you graduate. There are so many options for getting an affordable education.

Lastly, check out grants and scholarships. Depending on what age you are, your field of study, and where you live, there will be varying amounts of money available for your education. Even if you can’t pay for the entirety of your education, this might take care of a few thousand each semester. Who doesn’t like free money.

Now, when it comes to paying back the loans, there are several things you can do. If you’re concerned that you won’t be able to make the monthly payments, talk with your loan provider about your financial situation. Fresh graduates who are making entry level wages can usually work with their loan provider to lessen their monthly payments based on their yearly income. If that is too much for you, there are other options such as forbearance or deferral, which will put your loans on hold until your financial situation improves.  

Please know that every situation is different. I’ve covered everything that I’ve personally had experience with, but there are plenty of scenarios that just don’t fit within these suggestions. No one is perfect. These are simply the guidelines I would follow if I could go back and do it all over again. Don’t get too down on yourself if you haven’t followed these rules exactly (I know I haven’t). There is always time to improve your credit score and choose loans that will benefit you for years to come.

6 comments… add one
  • Dan Woerheide Mar 24, 2017, 5:24 am

    Matt, Great article. I would personally challenge how debt can be leveraged to build a better financial future. Borrowing money to increase wealth is counter intuitive. Especially when it comes to Car Loans, Vehicles Always go down in value. I would add that the Credit Score is a tool for those who choose debt as a way of life, like you I am not a fan of debt and prefer no loans at all. The FICO score is calculated solely on the consumers interaction with debt, there are no indicators of your personal wealth included. 1 million dollars today will not change your credit score tomorrow. In fact, if you use that money to pay off a debt and close that account, you will see a decrease in your score, as a penalty.
    Home purchases can be a large expense that most people don’t have patience for when it comes to saving. A home being a major purchase can still be done without credit (not to be confused with poor credit) there are no additional costs for doing so, and still retains current interest rates as any other mortgage.

    • Distilled Dollar Mar 24, 2017, 8:35 am

      Hey Dan, thanks for reading! I agree borrowing money for car loans is most likely a bad deal.

      I might challenge you back and ask if you think borrowing in 100% of the cases is the wrong move? I’m just thinking now if we borrowed to help start a business for example. Obviously it is risky, but that’s the cost of launching a business.

      • Dan Woerheide Mar 24, 2017, 9:54 am

        Matt,
        Great question. If you are going to borrow money it is certainly a big risk. I would counter with considering whether or not you are truly ready? Why not save to cash flow it, take the time to plan it and build the vision? At the very least I would suggest ensuring your personal finances are in order before delving in to borrowing for a business. I find that mixing finances and not being prepared personally lead to the most negative outcomes.

        If you’ve found a solid idea, know the market for it and have a significant chance of recovering your initial investment and no plans to borrow more, rather cash flow future growth, then it may be a consideration.

        It may also have a lot to do with the size of the business.

  • Mrs. Picky Pincher Mar 24, 2017, 7:58 am

    Wowza, congratulations on the podcast! That’s a real achievement. 🙂 I think going forward, the only loans I will use are credit cards and mortgages. We can easily buy cars with cash now, so there’s no need to finance. We do use rewards credit cards and pay them off each month. We use the rewards to pay for all of our Christmas presents. 🙂

    • Distilled Dollar Mar 24, 2017, 8:32 am

      Thanks! 🙂

      I agree on only having a mortgage and potentially credit card debt that I pay in full each month. I’m lucky so far to not have to have a car, so maybe that streak will one day come to an end. If that’s the case, I’ll prolly go the Millionaire Next Door route when it comes to buying a car.

  • Cody @ Dollar Habits Mar 24, 2017, 12:40 pm

    Enjoyed the guest post, Trisha, and congratulations, Matt, on the podcast success!

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