Living With Debt

3 Debt Traps That Can End Up Costing You Thousands

By | Monday, December 03, 2018

America isn’t a nation that runs on Dunkin’. We run on debt.

According to Pew Charitable Trusts, 80 percent of us carry at least some type of debt, and the New York Federal Reserve Bank recently reported that our nation’s total household debt hit a peak of $13.3 trillion — yes, trillion — earlier this year. And it’s not just student debt contributing to the problem. Total credit card debt hit a new record this year of more than $1 trillion.

Having debt is so common in the U.S. that it’s easy to forget how detrimental it can be to financial success if we don’t manage it well. And, honestly, the way most of us have been conditioned to think about debt isn’t helping us. Here are three common debt traps that are easy to fall into, and how to get back out — and back on track financially.

1. The “In-Case-of-Emergency” Credit Card

The summer before college, my mom helped me open a new credit card — just for emergencies, she said. And while I never had to use it, I realize now it didn’t do me any favors either. Who needs to save money when you’ve got a credit card handy?

Covering an emergency (and it’s easy to use that term loosely) with a credit card may seem like a good, quick solution in the moment, but fail to pay off the balance and compounding interest will ensure you pay a lot more for that flat tire than you had to. Better to start building an actual emergency fund little by little until you hit an initial goal of $1,000. That’s usually enough to cover a typical pop-up expense, like a repair or medical bill. Then keep going until you eventually have enough to cover three to six months’ worth of expenses.

2. Special-Occasion Debt

Intellectually, we know that special occasions, like vacations and the holidays, aren’t worth raiding any emergency savings we’ve built up. But when these expenses don’t fit into our regular budgets, either, it’s tempting to swipe a credit card.

This kind of thinking has big consequences, says Certified Financial Planner Gary Silverman. People who racked up credit card debt for last year’s holiday expenses started 2018 with more than $1,050 in debt, with one-third estimating it’d take five months to pay it off. Of course, saving ahead of time is ideal. But a little creativity can help us do more of what we want, too. For example, there’s nothing wrong with thoughtfully regifting an unwanted present or two this holiday season or challenging yourself to a $50 holiday entertaining budget.

3. Debt-Financing Depreciating Assets

Sometimes, it’s possible to leverage debt in a way that actually grows our wealth. This is called “good debt.” For example, student loans can help us pay for an education that yields a higher salary than would be possible to get without the college degree. And taking out a mortgage to buy a house today — well before we have the cash to buy it outright — allows us to own an asset that (we hope) appreciates enough over time to offset the interest we’ll pay on the mortgage.

Bad debt, on the other hand, is when we finance depreciating assets, such as taking out an auto loan to buy a new car that loses as much as 10 percent of its value as soon as we drive it off the lot, or tapping our home equity to pay for everyday expenses.

The key is educating ourselves on the difference and prioritizing long-term financial health over instant gratification today. “Borrowing is always presumptuous,” Silverman points out. “What if your investment turns out to be a dud? All debt — and all investments — should be approached carefully.”

Read the original article on Grow. Copyright 2018. Follow Grow on Twitter.

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