Lesson 4: Demystifying the World of Debt
Don't go shopping for sunscreen just yet.
While it’s true that loans are, in general, considered to be a better form of debt than, say, credit cards, not every loan is a “good” loan. In fact, if the item you want to buy will be consumed quickly and have no lasting value, taking out a loan is probably not a great idea. The payments you’ll be stuck with will continue long after the suntan fades.
As a rule of thumb, only take out loans on things that you need, that will ultimately benefit your financial standing, and that will increase in value.
If the loan is for something you can do without or will lose its value quickly, take a pass.
Before deciding whether a loan or credit card you’re considering is worth the risk, see where it fits in the debt spectrum below.
- Student loans. Generally speaking, a college education will increase both your ability to get a good job and your eventual earning power. That makes a student loan a good bet. However, before going into massive amounts of student loan debt, consider what your starting salary is likely to be—and how long it might take you to pay off your loans. If you’re interested in getting a good estimate of what starting salary you might have after graduating, use this calculator. Just remember, since you’re just out of college and starting a new career, chances are that your salary is going to be in the low end of the spectrum.
- Auto loans. If the car you’re buying is a reliable model that holds its value well and will get you where you need to go for years to come, it’s a good debt to take on. Just make sure you buy something that’s firmly in your budget and affordable to maintain.
- Home loans. If you buy wisely, taking out a mortgage can be good for both your credit score and your overall financial picture. Just make sure your new home is in a stable area with steadily rising home prices—and that you can afford it.
- Personal loans. Since you don’t end up with a concrete asset, personal loans fall into the bad credit category.
- Credit cards. Because credit cards offer “revolving credit,” meaning you can add on new debt just as soon as you pay off the old debt, they’re bad news. If you use a credit card, buy only what you can afford and never carry a balance.
- Payday loans. These are the worst of the worst. Short-term payday loans carry abominably high interest rates and are likely to get you in an even worse financial pickle than the one you’re already in.