What is consumer debt? And why you stay out of it!
What is consumer debt?
In essence, consumer debt, or bad debt, is money borrowed to purchase anything that does not generate income. Bad debt can also be called consumer debt because most of the time it is used to buy consumer products. These items include tablets, smartphones, TVs, video games, laptops, cars, and the list goes on. None of these items earn you any income.
Why you should avoid consumer debt
High Interest Rates
In many cases bad debt comes from the use of credit cards. Credits cards often carry very high interest rates. Interest is charged on the balance if the money borrowed is not paid back in full every cycle. This interest then adds to the balance of the money borrowed. In many cases people will forget this aspect of using a credit card and accumulate very high balances. If balances get high enough – the monthly payments the user makes may not be enough to cover both the interest charges and principal payments. In some some cases the debt can snowball into an amount far greater than the price of the original purchases and take years to pay off.
In almost all cases, those who accumulate consumer debt will have a minimum monthly payment. The higher the amount of debt, the higher the minimum payment. This monthly payment causes you to work today for goods you purchased yesterday. You are essentially stealing from your future to by these items today.
If you seek financial freedom, having high amounts of consumer debt will slow you down. Many people will be tied down to a job because these monthly payments must be made. If you lose this source of income then you might fall behind and this can damage your credit score – which can be very hard to fix. Once your credit score is impaired you will pay more interest on future borrowings, limit your ability to purchase a house (or even rent an apartment), and sometimes effect your job search.
If you ever had dreams of leaving your job and starting your own business – the payments from consumer debt may stop you.
Limits wealth building
Every dollar you use pay to pay down your consumer debt is a dollar you can use to invest. In order to invest you need a surplus of income over your expenses. Consumer debt raises your expenses and therefore lowers or even wipes out the surplus.
How to avoid consumer debt
The best way to avoid consumer debt is to not get in the habit of buying things you cannot pay off at the end of the billing cycle. If you do this you can still enjoy the benefits of using a credit card such as protection and credit building. Creating a budget of your weekly or monthly expenses can assist you in making the correct financial choices.
Consumer debt can also come from car loans and mortgages. Many mortgages span 30 years – that means every month for 30 years you have to make a payment. This will limit the risks you can take and your mobility. Car loans are similar, you will have a monthly payment for over 5 years.
To avoid this type of debt you may want to consider renting your home and buying cash and/or leasing your car. And as a general rule, if you are going to purchase these items with debt, make sure it fits into your budget so that you still have a surplus.
Getting out of consumer debt
If you are already in a large amount of consumer debt there is hope. The first thing you will want to do is make a list of all your outstanding credit cards and loans. List the balance and interest rate of each.
Then pick the one with the highest interest rate, which will likely be a credit card. Your goal will be to pay this card/loan off as FAST as possible. Continue making the minimum payment of all your other debt but take all the excess cash you can and pay that one card/loan off until the balance is zero. Go down the list and repeat. If you can cut down your expenses wherever possible to make larger payments to the debt.
The bottom line
The bottom line is that consumer debt can be bad to your financial well-being. It can put life events on hold and prevent you from building wealth and/or achieving financial freedom.
Instead of borrowing money to buy items that create a liability, and cost you more money through interest. You want to buy items that create income for you – those are assets. Assets include real estate, bonds/notes (which is money other’s owe you), stocks, business interests, and royalties.