Financial Literacy 101: Debt

Financial Literacy 101: Debt

Dec, 9th 2016

Welcome once again to Insedia’s “back to basics” series. Throughout this series, we’ll be examining some of the most important fundamentals in financial literacy. These principles will help guide you in how to make better financial decisions, no matter where you are in your life. In our first section, we explored the importance of budgeting, and now, we’ll be talking about debt.

Debt is the amount of money you owe another person or, more commonly, an institution. Typically, debt is accumulated when borrowing money for a major purchase, such as a college education or a home, and it is paid off gradually in the form of installments over time, which can last for many years depending on the size of the debt and the conditions of the loan.

Good Debt and Bad Debt

Generally, debt isn’t desirable (for obvious reasons), so young people sometimes fear debt or avoid it at all costs. However, there are forms of “good” debt to have. Good debt is debt that gives you some kind of benefit that’s worth the interest you’ll pay; for example, home mortgages are usually considered “good” debts to have because they enable you to be a homeowner, and won’t cost you much in the long-term when their value appreciation is considered (especially compared to paying rent). Good debt also allows you to create a reliable payment history, which can build your personal credit (we’ll be looking at credit scores in part four of our series).

How Debt Works Against You

Debt interferes with your life in a handful of ways:

  • Interference with buying power. First, making mandatory monthly payments can interfere with your buying power in other areas—preventing you from saving money.
  • Compounding interest. The biggest danger with debt (especially credit card debt) is the power of compounding interest. Over time, you’ll earn more interest on your principal and more interest on the interest you earn, resulting in you paying back far more than you originally borrowed.
  • Credit score effects. Having too much standing debt can lower your credit score, which can interfere with your ability to secure new loans, find a place to live, or even get a job in some cases.

How to Pay Down Debt Quickly 

If you’re already in debt and you want to get out, there are a handful of general principles that will help you pay down that debt quickly:

  • Stop the bleeding. Don’t accumulate any further debt. Don’t use your credit cards, and don’t apply for new loans.
  • Lower your rates as much as possible. Negotiate with your lenders to lower your interest rates, or consolidate your debt under your lowest-interest account. The less interest you’re paying, the better.
  • Create a plan and a budget. Next, create a budget for yourself and a long-term plan for how to pay down your debts. Stick to it.
  • Boost your income. To pay off your debts even faster, secure an extra stream of revenue to dedicate solely to paying off your debt, such as a freelance opportunity or side gig.

Debt isn’t necessarily evil, but it can interfere with your short and long-term financial capabilities. Avoid accumulating bad debt, and when you do, pay it down as soon as possible to remain in good standing. Once you do that, you can focus on saving more money—the focus of part three of our five-part series.

As always, if you’re interested in learning more about financial literacy and how to get your finances back on the right track, be sure to join the Insedia community!

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