3 times the debt can be a useful tool | Smart Change: Personal Finances
In some corners of the personal finance advice world, getting into debt is about the worst thing you can do. And yes, some forms of debt, especially those that charge high interest rates, can keep you locked in a cycle of debt for years.
Still, there are times when getting into debt serves a purpose in your overall financial picture. Debt isn’t always bad, although there is always a risk of it piling up over your head. It’s simply a tool you can use to afford a very large purchase without depleting your savings.
“I think it’s so important that people aren’t afraid of debt, but rather see it as something you can use to your advantage,” says Kara Duckworth, certified financial planner and chief executive of the customer experience at Mercer Advisors.
Here are some examples of when the ability to borrow money can be useful.
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For something that can rise in value
Debt is often categorized as good or bad, depending on why you’re borrowing money and how much interest you’ll pay.
“Good debt can help you move forward in your career and in your life,” says Mark Reyes, Certified Financial Planner and Senior Director of Financial Aid at Albert, the financial services app. “On the other hand, bad debts can prevent you from achieving your goals.”
Mortgages are often cited as an example of good debt, since a house can appreciate in value. “It’s not a bad debt to have; it’s going to put a roof over your head,” says Bill Hampton, Certified Financial Education Instructor and CEO of Hampton Tax and Financial Services in Atlanta. Of course, borrowing more than you can afford or not understanding the terms of the loan can lead to financial risk.
Student loans are another generally recognized example of good debt, since your education can increase your lifetime earning potential. According to Hampton, “You’re going to be in debt for a number of years, but it will get you a better paying job. But if your middle finger doesn’t support your debt, it could hold you back.
To finance a major purchase
Now let’s move on to bad debt: credit cards. Not only do they charge high interest rates, but you can continue shopping even if you still owe money from previous months. It’s easy to end up with a balance that keeps growing, no matter how hard you try to reduce it.
However, some credit cards offer interest-free promotions that you can use for a large purchase. These promotions allow you to spread a cost over several months, often 12 months or more, depending on the card. Make sure your budget allows you to pay it back within the promotional timeframe, before interest arises.
If you have existing debt, balance transfer cards allow you to transfer that debt and pay no interest for months. But as always, make sure you understand the terms of the card you’re using – you’ll likely pay a transfer fee and the interest rate will go up once the promotion ends.
Once you own a home, borrowing against its value in the form of a home equity loan or a home equity line of credit — or HELOC — can free up money for home renovations. Homeowners can choose to do this instead of putting renovation costs on a credit card that charges a higher interest rate.
“Depending on how much equity someone has and depending on their specific situation, it might be better to leverage that rather than a credit card or personal loan,” Reyes says. “It’s kind of the lesser of two evils.”
To meet unforeseen costs
You’ve heard the lecture before. You need to have emergency savings. But that’s the problem with emergencies – they happen randomly, and sometimes simultaneously, whether you were able to save money or not.
These are the times when you may need to make the best less optimal decision, which may mean going into debt. HELOCs and personal loans can be a low-interest way to borrow money to cover an emergency, but credit cards can also serve as a source of emergency funding.
If an emergency expense lands you in credit card debt, Hampton recommends making a plan to pay off that balance in a few paychecks. You can also take other steps to reduce the cost of your debt, such as transferring the debt to a balance transfer card or seeing if your credit card company will meet you halfway.
“Consider calling your credit card company and try to negotiate a lower interest rate than what you’re being charged,” Reyes says. “It’s not always successful and it’s not likely, but it’s worth it.”
This article was written by NerdWallet and was originally published by The Associated Press.