Debt is a tricky thing because sometimes it’s good and sometimes it’s bad. Most financial messes are caused by poor debt management or just lousy risk management. Over the next two weeks, I’ll share a few basic rules to keep you out of trouble.
Rule#1: Never finance the purchase of a depreciating asset.
In other words, never secure a loan to buy anything that falls in. For instance, a car is a depreciating asset. It declines substantially in value the moment you drive it off the showroom floor and yet you are paying interest and financing charges making the car even more expensive. Instead, the best way to purchase a car is to save the money now while you are still driving your old one. Financing an auto purchase with a five year loan will cause you to pay 20% more for a car due to the interest (assuming 7% interest rate). If you save for the car over five years (invested in a money market account earning 5%) it will cost 12% less because of the interest you have earned.
If you finance clothes, furniture or a nice lifestyle using your credit cards the costs are even higher. That $30 sweater may end up costing you well over $100 dollars. It is risky to extend yourself using credit cards. What if you can’t make the payments? The interest rate triples overnight and not just on the card you are delinquent but all of them. Most of America is only three pay checks away from default and eventual homelessness. Minimize risk by minimizing debt. Be smart, plan for a rainy day by saving and keeping your lifestyle expenses in check.
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