Debt is an important financial management tool. If used with discipline and tact, it can help individuals and companies to overcome a current lack of money in order to achieve a greater goal. For example, a mortgage can be considered an investment because most real estate increases in value over time, and you can get tax breaks if you have one. Student loans are another example of good debt since higher education is linked with opportunities to earn a larger income, thus making them worth it.
Consumer debt is thought to be the least beneficial type of debt since it involves borrowing to pay for goods or services whose value does not increase over time. This includes expenses such as rent, transport, food and entertainment. They usually attract high interest rates and they do not have any tax incentives. However, due to harsh economic realities, they can be unavoidable.
Debt is a tool you use to get the things you need but may not be able to afford at the moment. It can also provide a much needed cushion during emergencies. For this reason, you need to weigh your options carefully.
Ensure you understand the interest rates and fees before you apply for any form of credit. The cost of a loan includes interest, fees and penalties. Interest and fees added together are expressed as an annual percentage rate (APR). Compare the APR charged by several providers before settling on a source of credit.
How much consumer debt should you have at any point?
Managing your consumer debt has its advantages. Paying off small debts in time helps to establish your creditworthiness, which in turn could create opportunities for you in the future. A positive credit history could help you secure loans with lower interest rates, for example. Debt management also helps you build discipline, which brings you closer to achieving financial freedom.
It is advisable to keep your overall debt load below 20% of your annual net income. In addition, make sure you consider the interest that is accruing, not just the amount you borrowed, when thinking about your debt. Remember, even as you make regular repayments, you may be charged interest on the pending balance. Read more on managing your debt here.