Understanding consumer debt: The good, the necessary, and the …

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Using credit cards is a fact of life for many of us, but the days of leveraging ourselves into stratospheric levels of debt are long gone. No longer is it fashionable (or wise) to have accordion files of credit cards in our wallets. Here are some tips for debt management and understanding which debts can work in your favor, which debts are necessary, and which ones are lethal to achieving financial security.

Debt management starts at home: Looking in the mirror and in your wallet

Understanding how you use credit cards is a big step toward eliminating credit card debt. Keep track of your spending for a month and categorize your credit card expenditures. Chances are you’ll immediately notice certain areas where you can cut back or stop spending altogether. Identify where you can cut back, and be realistic. It’s not likely you’ll never order another pizza, but doing it once a month instead of every Friday night is a realistic choice.

Getting to know your debt: What kind are you carrying?

Financial experts typically categorize debt as good or bad. We’re taking a different approach by categorizing consumer debt as good, bad but necessary, and just plain bad:

• Good debt: This represents an investment in your future. Purchase money mortgage loans and student loans are sound investments as long as you avoid borrowing beyond your means. Note that we specified purchase money mortgage loans. A few years ago, home equity loans and lines of credit were funding everything from speed boats to luxury vacations. Borrowing against home equity can be good or bad, depending on your reasons. Interest paid on mortgage loans and student loans is typically tax deductible; consult a tax accountant or financial advisor for details.
• Bad but necessary debt: We’re living in uncertain economic times, and unemployment and loss of health insurance can send your finances straight down the drain. Some credit card companies offer a period of low or no interest for a specific period; this can provide several months for you to pay off a medical bill. There are also dedicated credit cards available to pay veterinary and dental expenses; these plans offer interest free repayment periods depending on the amount financed.
• Bad debt: Meeting your girlfriends for an afternoon of retail therapy? Cash is the new plastic. Take your debit card or cash instead of your credit cards. Avoid getting hooked into opening new credit card accounts; you may receive deep discounts on your purchases for one day, but if you’re paying off your credit card over time, any discount you received is eaten up by interest.

Identify and manage your spending style, your debt categories, and what you owe for each to establish a foundation for planning and prioritizing how to pay off your credit card debt. Seek debt consolidation and credit counseling help to help you resolve unmanageable debt and put your budget back on track.

Post written by Karen Lawson

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