Growing up, I never thought of borrowing money as a tool, rather it was a sign of not having enough money to pay for whatever you were trying to buy. It wasn’t until I started working that I learned more about it. Internet has a lot of information about types of debts, so I’ll skip that part. You can read about it on investopedia, bankrate, or cnbc to name a few websites.
What is considered bad debt may not be so depending on how you use it – it can be explained by considering the cost of borrowing money. Interest is what we pay to use other people’s money (OPM); there are several things to consider when borrowing, some of which are following:
- Total amount borrowed
- Fees associated with loan process
- Interest rate
- Length of borrowing
- Early repayment terms
Looking at the bigger picture, this can be used to your advantage and possibly also help acquire good debt.
Bad Debt #1: Car Loan
Last year when I was buying a car, I had thought about paying cash since car loan is typically considered a bad debt – it seemed like a good idea until I ran the numbers:
- I was getting a car loan for upto $25K at 1.99% without any other processing fee or extra charge
- I was also considering buying a house in near future
I could pay cash for the car and figure out the house down payment later or, which I eventually ended up doing, take a car loan an put more cash towards the house. Our home loan had interest rate of 4% and we didn’t have to pay PMI because of the extra down payment I could afford. Considering that the interest for the car loan is half of that for the house, it turned out to be a good deal.
Bad Debt #2: Credit Card
I always pay credit card bills on time and never carry any balance. In this one instance, I had to pay the bill on Thu and I was going to get paid, a day later, on Fri. I paid the minimum balance on Thu and waited to get paid to clear rest of the balance; total interest paid <$1. The high interest rate for credit card is the yearly rate and unless you plan to not pay for an entire year, the interest doesn’t accumulate much. Compare that with payday loan or bank overdraft fee, both of which cost more than $30!
Bad Debt #3: Store Credit card:
I am not a fan of store credit card in general, primarily because those can’t be used anywhere else. After buying the house, we still had to buy appliances and furniture. I did research on what I wanted to buy and compared prices at 3-4 physical stores besides checking online. Finally went to the one which had the lowest price for what we wanted (considered brand name, type of appliance, size etc.), they were also willing to price match.
I was going to buy from there for the lowest price alone, but they offered more discount if we used store credit card. The card also came with 0% interest for 18 months, which was an added advantage. That’s the only time I’ve used store card and didn’t think it was a bad debt because of the savings and not having to pay any interest.
When making a decision about using cash vs OPM, consider above factors and remember to do your own calculation not what the seller shows you.
P.S. My friend and I had this joke about me not willing to pay $500 to get my mustang’s broken window repaired. His exact words, “You didn’t want to pay $500 for the window, so you bought a new car for $15,000?!” I had my reasons.