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Home » Random

Control your debt

Day 736 / 365 - Ski holiday Ouch ( credit crunch debts bills )
Creative Commons License photo credit: xJasonRogersx

In The Secrets of Becoming Rich we talked about the six steps to creating a solid foundation to build your wealth. In case you’ve not read the six steps, you can catch up here.

This post is part one of a two part post looking at controling your debt.

In this post specifically, we’re going to look at the difference between Good Debt and Bad Debt, in part two we look at strategies for dealing with bad debt.

Good Debt v’s Bad Debt

The secret to long term financial freedom is similar to going on a diet. We all know that in order to loose weight we need to eat less and exercise more, and yet, diet books frequently top the bestseller lists. As people look for the quick fix to go from overweight to athlete.

With our finances it’s about spending less and saving more. If it only it were all so simple, we’d have washboard abs (a six-pack) and be millionaires, sadly it’s a touch more complicated in reality.

In recent years the economy, both in the UK and US, has grown due to people remortgaging their houses and using them like a cash point or ATM.  The abundance of easy credit deals and over willingness of banks and other lenders to give you money means that, chances are, you’ve bought stuff on finance.  Sadly many people have financed credit by getting more credit.  Debt on top of debt. A kind of debt pyramid if you like.

With credit deals disappearing faster than a stripper’s clothes, the party is over for many people especially as global interest rates start to rise and the employment situation worsens, meaning that the ability to repay debt becomes more difficult.

Just like we know eating chocolate bars is not good for your health or spending money on Jimmy Choo’s is not good for the bank balance, yet we still do it. it’s all part of being human and being subjected to TV or magazine adverting and peer group pressure.  I read recently that if your friends are overweight , you are also more likely yourself to be over weight.  Therefore it follows that if your friends are in debt, then there’s every likelihood that your friends will also be in debt.
In this post we look how you can stop being a follower and be a financial athlete!

So how do we do we do this?

Chances are you have some debt.    Some of it will be debt that some personal finance pundits refer to as good debt (used to finance assets which go up in value  e.g. a house or fund your education which enables you to get a better higher paying job) from bad debt (assets which go down in value such as a TV, Stereo or car).

So, not all bad debt is bad.

The answer is it’s how you use it.

For example, I have a loan on a sofa. Generally speaking, that would be bad debt, except that it’s a 4 year interest free loan from the shop I bought it. I had budgeted for the amount and I could afford the monthly payment.

Secondly, the use of credit cards gives you an interest free loan, so as long as you pay the credit card in full at the end of each month, the use of credit cards and the like is no big deal.

In some situations, the use of credit cards for larger purchases gives you some consumer protection as the credit card company will be responsible in the event of any problems with the retailer who provided you with the goods and services.

Again credit cards can be good if you get rewards such as cash backs or rewards every time you use them. I’ve just had a few days away in New York, with the flights paid for with air miles.  But the important thing is to only have a credit card reward scheme if it’s worth something to you.   There’s absolutely no point in getting credit cards for the air miles if you never fly anywhere.

Equally, you should not have a credit card which charges you a membership fee unless the benefits of membership far outweigh the costs. For example ‘free’ life and travel insurance, access to airport lounges etc. If these benefits are things that you would use and you cancel the expenses you are paying for these services, then maybe they could be worthwhile.

So, that’s an overview of good debt v’s bad debt.   In part 2 we will look at strategies for dealing with reducing your debt.

What do you think?