Basic Steps to Reduce Debt
Submitted by Larry Frank Sr. on Tue, 08/27/2013 - 12:00pm
Most people pay off debt the way they swat flies: Willy-nilly and at the first
bug that lands or bill that arrives in their mailbox. Debt comes in different
forms, however, and you should realize what to pay first.
Most people also think there are two kinds of debt. But good debt really
comes in two forms and I make a distinction. Here are three kinds of debt:
Good Debt: CNNMoney’s Money 101 lumps together what I call good
debt and necessary debt. Others see the costs of small-business
ownership, real estate and even investing as good debt.
Small businesses can fail and market holdings tank. A home mortgage is
the only good debt in my opinion, assuming the home value appreciates
over time and offsets ownership expenses. Even that’s far from a given
now in many devastated housing markets.
Necessary Debt: I agree with Money 101’s calling car and college
examples of necessary debt: You need transportation to get to your job
and make money, and you need money for education to improve your
skills and make more money.
I categorize these as necessary to avoid the notion that your kind of debt
doesn’t matter. It does. Too much transportation and you overpay to park
that expensive transportation – your car –either at home or at work most
of the time until the car becomes a bad debt. Also, too much education
and your job may fall short when it comes to paying off tuition debt.
At an extreme level relative to your earning power, either or both of these
debts crowd out other living expenses. Necessary debt easily becomes
bad debt if you go overboard.
Bad Debt. This means paying today for yesterday’s – or even older –
consumption. Nothing but bills come in anymore for such debts as credit
card use or other sources of loans for something you paid for and got
little gain from. Credit cards – and especially keeping a debt balance on
one – come with interest rates often exceeding rates on consumer loans,
and payment schedules ensnare debtors in maximum costs.
Other examples of bad debt: clothing, vacations, fast food, groceries and
gasoline, all of which you commonly buy with borrowed money off a card.
Everybody needs a vacation and likes to eat out. But pay those
expenses out of money you have now without piling up more debt you
have to pay for anyway out of money you make eventually.
For more help, CNNMoney also offers a debt-reduction calculator.
Your priorities for reducing debt start at the bottom of this article and
work up. First attack bad debt, then maybe necessary debt – especially if
you did go overboard on spending for transportation or education – and
finally possibly pay down the mortgage. Attack that last debt, incidentally,
only if you are saving enough for retirement.
No one erases all debt in every aspect of life, or could hope to. All the
more important, then, that you know the kind of your debt and what to
go after first.
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Larry R. Frank Sr., CFP, is a Registered Investment Adviser (California)
in Roseville, Calif. He is the author of the book, Wealth Odyssey. He has
an MBA with a finance concentration and B.S. cum laude in physics with
which he views the world of money dynamically. He has peer-reviewed
research published in the Journal of Financial Planning. He also
writes Better Financial Education.
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