GOOD DEBT VS BAD DEBT
The first step in learning the strategies to get out of debt quickly is knowing the difference between good debt vs. bad debt, and how to control it.
Bad debt charges interest on items that lose value over time. Using a credit card for a consumable item like buying clothes, going out to eat, or a loan for a car that depreciates in value is bad debt. Good debt has a return on investment. Money borrowed for an education, a business, a home, or anything that adds future value is good debt.
- your education demanding higher pay for a better job
- your business that buys equipment that produces more products for less money.
- allows you to deduct the interest on your tax returns (1040).
Good debts can turn into bad debt. Although educational debt is considered good debt because it would pay itself back with a higher paying job, that isn't always the case. College graduates that have student loan debts that outweigh their earnings are considered bad debt. Some law students have sued their schools because the debt was much higher than their potential earnings. During the recession of 2008 older workers went back to school to get a degree, then did not get hired because of age bias.
Investing in yourself may not pay off the way you hope it will. Be cautious when taking on debt. Understand debt and how it can hurt or help.
UNSECURED VS SECURED DEBT
An unsecured loan, is a good faith loan. It means the lender believes you will pay the loan back without securing something of value from you to secure the loan if you do not pay. For unsecured loans, interest rates can be over 30%. For 2020 and 2021, I have seen the average around 15% -30%.
An investment with Standard and Poor’s 500 (S&P 500) pays around 10% a year. Very few if any have ever beaten the S&P 500. If 10% is a good return on your money, then it is hard to justify a loan where the interest is higher than 10%, unless it is a good debt or it is paid off each month before the interest is charged.
Secured loans are secured by an asset you have like a home or vehicle. The interest rates are lower because if the loans aren’t paid, the lending institution can repossess your asset. They are usually between 3 and 6% but it depends on your credit.
HOW INTEREST RATES ARE DETERMINED
If you have a low credit score, you will pay a higher interest rate. If your score is high, you will pay a lower interest rate.
Low credit score doesn’t mean you don’t pay on time. You can be 100% paid on time, but if you have a lot of loans outstanding that are maxed out or not a variety of loans between a car, house, or revolving credit, such as a credit card, that can also be a factor on a low credit score.
In the United States initial interest rates are determined by the Federal Reserve bank. Rates are determined based on the state of the economy. If the economy is flat or consumers aren’t spending, then the Federal Reserve lowers the interest rates to encourage spending and boost the economy. If everyone is spending and the Federal Reserve is concerned about out-of-control inflation, it increases the interest rate.
When interest rates are low the dollar is devalued, and imports are more expensive to purchase. The opposite is true when interest rates are high. When interest rates are high the dollar has more value, foreign products are less expensive to buy, and products leaving the U.S. are more expensive.
Strategies to get out of debt quickly include how to get the best interest rates or how to manipulate the interest you pay. An example of manipulating interest rates would be refinancing a home when the interest rates drop. Another example is transferring a balance from one credit card to another with a lower interest rate or no interest. This strategy helps avoid paying interest for a period of time.
HOW MONEY, BANKING, AND CREDIT IS MANIPULATED AND WHO BENEFITS
As part of my finance degree, I took a “Money, Banking, and Credit” class.
Essentially, we were learning how to manipulate money to our advantage and capitalize on it. Creating financial models on spreadsheets and determining if a purchase would increase our profits.
EVERYONE SHOULD KNOW HOW MONEY IS MANIPULATED FOR THEIR BENEFIT BUT NEVER AT THE EXPENSE OF OTHERS. Corporations know how to manipulate money at the expense of others. You need to understand what is being offered is in your best interest.
HOW LENDING INSTITUTIONS MANIPULATE DEBT TO THEIR ADVANTAGE
A simple explanation of a checking account. In the eyes of the bank, you are not only their customer, but you are also their creditor.
The more money you have in your account the more money the bank can lend out.
Depending on what kind of bank account you have, it will determine whether you earn interest and how much.
It is also why there are minimum balances on certain accounts. If you fall below the minimum, you will get charged.
For most banks the interest you earn is below the inflation rate, which means you are losing money in your account.
When opening bank accounts/credit unions/investment banks/brokerage firms, check their fees and interest rates. See if the institution you are banking with offers “sweep accounts” This is an account that automatically transfers your funds at the end of each business day into a higher earning investment like a money market fund. It is a way to curb some inflation losses.
DEBT CAN BE USED TO CREATE WEALTH.
Businesses purchase machinery to decrease time spent servicing or producing products.
Businesses hire financial analysts because they have the skills to know how to leverage debt. For businesses it is not strategies to get out of debt quickly but how to manipulate the debt to their advantage. Financial analysts of large corporations use formulas to determine if the loan or debt would produce a high enough return. Will the return on that purchase be greater than the cost, when accounting for interest, amortization, and depreciation? If the financial analysts’ numbers indicate that it would increase the profits, then the item is purchased, and the interest can be written off on taxes.
YOU ARE GOING TO USE ALGEBRA AFTER HIGH SCHOOL
Understanding algebra, probability and statistics and some business calculus can be very beneficial when trying to manipulate things in your favor.
Remember in high school asking the teacher, “When will I ever use algebra?” I would be elated if I got a “C” on a math test. Most of my grades in math were D’s.
It wasn't until I went to college later in life that it clicked and why algebra was important. My teacher told me, “When you were in high school, you didn’t see the use for it. Now you do.”
Every time you borrow money to buy a car, purchase a home, or use a credit card to make purchases algebra is used.
Here is an example:
If I have 4 apples, but I need 9 apples, how many more apples do I need?
4 +? = 9, instead of using a “?” we use an “X”
So, it looks like this:
4 + X = 9,
we know if we subtract 4 from 9, we get
9 – 4 = X,
so: X = 5,
I need 5 more apples.
Learning the basics of algebra and probability and statistics will help you determine if you should get a loan and are able use it to your advantage.
EXAMPLES OF HOW TO CONTROL DEBT.
Strategies to get out of debt quickly should start before getting into debt, by practicing good habits prior to borrowing money. If you have a high interest rate credit card, don’t purchase anything you can’t pay off at the end of the month.
If it is a school loan be careful about whether the debt for education will return to a higher paying job. Be careful about consolidating your school loans with a private company. The interest will no longer be tax deductible. With government loans you can write off the interest rates when filing your taxes. Look for ways to have the education pay for itself, through scholarships or paid training.
When buying a home, consider the market and interest rates. Different strategies for different markets.
Be careful of interest free loans. Usually these are loans where the interest is delayed until a later date. The minimum monthly payment is often not enough to pay for the loan in its entirety before the interest kicks in, then you are charged interest on the entire amount regardless of how much money you paid on the loan.
If you do not have the money for something don't burden yourself with more expenses that you can't afford.