Have you heard of “good debt” vs. “bad debt”? We’ll explain those terms below. When you’re making a plan to pay off debt, it’s usually wise to pay down your “bad debt” first. As a bonus, the more debt you pay off, the more positive impact you can see in your credit score.
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What is Considered Bad Debt?
What is “bad debt,” exactly? Bad debt is debt that has high interest rates, which makes it very difficult to pay off, and no long-term value. A high-interest credit card bill for a new wardrobe = bad debt.
On the other hand, “good debt” is debt you take on with the hope of gaining value or generating long-term income. Taking out student loans to pay for a college education that will earn you a higher-pay job and a brighter future is the perfect example of good debt.
How To Avoid or Pay Off Bad Debt
Having high-interest credit cards on which you’re using more than 30% of your credit line can be considered bad debt. If you use all of your available credit and only make the minimum payments, you will end up paying a lot more than you originally spent. A pair of shoes that seemed like a good deal at $100 could end up costing you double that on a high-interest card.
Check your statements to see what your APR (interest rate) is, and many times there is a section calculating how long it will take you to repay the debt based on different monthly payment amounts. It will look something like the chart below:
Total debt: $1,000 with a 20% interest rate
|Payments||Time needed to pay it off||Total paid on $1,000 of spend|
|Paying the minimum payment of $25 per month||5 years and 6 months||Approximately $1,661 total|
|Paying $75 per month||1 year and 3 months||Approximately $1,141 total|
|Paying $150 per month||9 months||Approximately $1,068 total|
See the difference? Don’t pay more for your stuff!
Pay off your cards with the highest interest rates and use them only when needed. Remember, once the card is paid off, it’s a good practice to keep the line of credit open, as closing your accounts will negatively impact your credit score.
Payday loans are the epitome of bad debt. They are the worst debt! Payday loans are accompanied by astronomical interest rates. The national average interest rate for these types of loans is almost 400%! Payday loans may seem enticing when you need that extra cash to get by, but payday loans come at a very high cost.
It can easily create bad debt if you don’t pay it back by your next paycheck. In short, don’t use payday loans at all. Ever. Instead opt for options that will not harm your credit and has 0% APR like MoneyLion’s Instacash cash advances.
Store Credit Cards
You know that moment when you’re checking out at a store and the cashier asks if you’d like to save 20% on your purchases? Then she tells you all of the fabulous rewards you’ll receive by signing up for their credit card. Just say no! Having too many store cards is an easy way to rack up bad debt.
Most in store credit cards have “instant approval” but come with high-interest rates — on average, in-store credit cards carry a 26% APR. Let’s say you opened the card and saved that 20% on your purchase, but you didn’t pay pay the total balance when your statement came in. Guess what? That 20% you saved just went out the window and now you are paying an additional 5-6% for your purchase on top of that. If you are consciously making an effort to be debt free, skip the in-store credit card traps.
How To Pay Down Bad Debt
Here are several steps you can take if you find yourself drowning in bad debt.
Step 1: Make A Plan
Gather all of your debts so that you have them in one place. List the amounts you owe and then determine which debts you should pay off first. It might seem most plausible to pay off your highest debts first, but the opposite could actually be true. Instead, you want to prioritize paying toward the highest interest debt first and work your way down.
This will help you pay the debt that is consistently accruing high interest each month and adding to the total balance at the fastest rate. Once you’ve got your highest interest debt under control, you’ll be one step closer to being free of bad debt.
Are any of your debts in collections? Go directly to a collections agency to pay it off or get some credit counseling from an accredited counselor.
Step 2: Call Your Creditors
Ask each lender about lowering your rate, changing your payment date, or dropping any late charges. Some creditors may even settle for a lower amount due, but make sure the amount you offer is reasonable. Also, confirm everything you discuss with the creditors in writing before you pay. This will protect you in the long run just in case a lender requires you to owe more than what was agreed.
Step 3: Make Payments – Pay More Than The Minimum
Make payments consistently and on time. The key to paying off your debt faster is to always pay more than the minimum. This is where budgeting will come in handy. Plan ahead so you know how much extra cash you can afford to put toward your debt. Remember the chart from above? It’s easy to go on autopilot and just let your minimum payment get withdrawn from your checking account, but do you really know how much more you spend by doing that? If you can add a little extra each month the timeline for paying off debt can decrease dramatically.
Step 3: Consider a MoneyLion Loan
Many members use our Credit Builder Plus loan to pay down their high-interest credit card debt.
The cool thing about our credit builder loan is that everyone who qualifies will get up to $500 cash today. Those who qualify for less than $500 up front will have the remainder of their $500 loan saved away in a credit reserve fund where it sits and collects interest. You get to save and build credit at the same time. And when you pay your loan in full, you get the money from the credit reserve account to enjoy!
This easy and affordable option through MoneyLion allows you to get up to $250 in cash at 0% APR instantly. You don’t have to worry about interest rates, fees or waiting days for approval. Instacash short-term cash floats do not affect your credit in any way and are a great way to make a quick payment on a loan that’s accruing high interest.
Getting Rid of Bad Debt
Having good credit means unlocking the doors to the milestones you’ve been dreaming about. But in order to get there, you need to be aware of bad debt and how that can be detrimental to your credit score and your financial potential down the road. Take the proper steps to improve your credit and eliminate the bad debt that’s holding you back.