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Managing Your Debt, Part 3
Welcome to part 3 of this “Managing Your Debt” series. In the previous section, we explained how you can find out how much debt you have as well as the amount you pay toward that debt each month. Additionally, you learned about some of the possible reasons why you’ve accumulated the debt that you have.
In this section, you’ll see the price you truly pay by having a lot of debt. We’ll also look more closely at how different types of debt work.
1. How Debt Affects You
Being in debt affects pretty much every aspect of your life. Those who are deeply in debt know what it’s like to turn down dinner invitations with friends or to skip out on an important community event because they can’t afford it.
This only scratches the surface, though. Here’s a deeper look at the impact that debt has on your life.
Money Issues Cause Marital Strife
According to a college professor, money arguments count as one of the chief predictors of divorce. Student loan debt is said to be the cause in 1 in 8 cases of divorce. Clearly, debt carries devastating personal consequences with it.
Future Income Obligations Vs. Future Money Goals
A good chunk of your current paycheck as well as a big part of future paychecks will go toward paying off your past debt. This puts the kibosh on many of your future plans/ goals you have for your money.
Basically when you’re in debt, your monetary attention is divided, so to speak. Because you have to pay down your debt, you will not have money to put toward goals, like buying a home, saving for your kids’ college education, or putting money away for retirement.
Money is a resource like anything else. When you use it for one purpose, you’re deciding not to use it for another. If you incur debt, then you’ve decided to use your future income to pay down that debt instead of putting it toward your future goals.
Interest and Fees
A primary disadvantage of using a credit card or getting a loan is the amount of interest you’ll have to pay. Big loans such as home loans tend to cost you a great deal in interest. In fact, if you look at your loan’s repayment terms, you’ll often see that a good portion of your money goes toward interest and not the principal of the loan.
The amount of interest reduces over time because eventually, your principal goes down. This, in turn, makes your interest go down because the amount of interest you are charged is based on the amount of principal you have.
Another way that debt takes a big bite out of your money is through fees. For example, credit card companies often charge consumers a yearly fee to use their card in addition to charging them interest on the amount they’ve borrowed. You may also get charged late fees if you pay your bill late.
Additionally, other types of credit holders, like car companies, also have fees that they charge. They may charge you a documentation fee, a closing fee, etc. The same can be said of real estate transactions. If you were to buy a home, you face paying lender fees, title and/or attorney fees, appraisal fees, and escrow fees, to name but a few.
The best way to find out if a creditor charges additional fees is to read the fine print in your contract. If any thing in your paperwork is unclear, be sure to ask about it.
2. How Debt Works
As you are probably starting to discover, there are many types of debt. This section gives you an at-a-glance look at the many different types of debt that exist.
Installment Loans
Installment loans are just like they sound. That is, you borrow a big chunk of money to pay for a car or your home or a semester of school. Then, the creditor bills you in installments, which you pay over a long period of time, sometimes, over many years in the case of bigger ticket items.
The amount of time it takes you to repay the loan is fixed. For example, you may borrow $1,000 from your bank, which you agree to pay off over the course of 12 months. This means the bank gave you a 12-month installment loan.
Revolving Credit
A revolving line of credit differs from an installment loan in that there is technically no final payoff date as there would be with an installment loan. Banks set up credit cards with a revolving line of credit. Basically, once you pay down your balance and your credit is opened back up, you can use the line of credit again.
For example, if you have a credit card with a $2,000 limit and you have $700.00 of available credit, then you can spend $700.00 (not $2,000). However, if you pay down your credit card debt until it’s at zero, then you have $2,000 that you can spend again.
How much available credit you have on a revolving credit account depends on how much you’ve paid on your bill. Also, you can continue to use the credit you have in definitely as long you continue to pay on your line of credit.
This type of credit comes with a minimum monthly payment. Unlike the installment loan, which gives you an end payoff date, you never get one with a line of revolving credit. Therefore, your payment only goes away once you pay your card back down to zero.
Finally, credit card interest compounds, usually daily. This means that if you keep a balance, the amount that you owe the credit card company will continue to grow, even if you pay the minimum balance each month.
Here’s a simple example. Let’s say your credit card company charges you 15% interest to use its card. Let’s also say that you have a balance of $2,000. Initially, you’d owe $2,000 on the card balance + $300 in interest, leaving you with a total of $2,300 that you would eventually owe your credit card company.
Now, let’s assume that you paid a minimum payment on the balance, which is $50, bringing your new credit card debt to $2,250. ($2,300 - $50 = $2,250.)
However, your balance is not going to remain at $2,250 for long because of the power of compound interest, which works in your credit card company’s favor in this case.
On the next billing cycle your credit card company will charge you 15% interest on $2,250 because your credit card company charges you on the total balance, not how much you initially borrowed.
Final Thoughts on Part 3
Carrying debt affects you in so many ways. Paying high interest rates on credit cards and loans really takes a bite out of your budget. The same can be said for the hidden fees associated with some credit cards or loans.
Finally, debt gets in the way of your future goals because your future income is already obligated to pay down your debt. Having money issues also takes its toll on relationships, making it all the more important for you to get control of your debt before it gets control of your life.
