There are many “do’s” and “don’ts” when it comes to wise financial planning and stewardship. But many financial planning experts would agree that at or near the top of the don’t list would be the following simple piece of financial advice: Don’t fall into debt.
“Few things have the potential to derail financial plans more than accumulating excessive amounts of debt,” says David Lerner, CEO of David Lerner Associates. “This is why many experts refer to debt as “the four-letter word” of financial planning.”
Timeless advice from the bard
“Neither a borrower, nor a lender be,” wrote William Shakespeare, “for loan oft loses both itself and friend.” This sage advice is as true today as it was when it was first penned 500 years ago.
Why is debt so potentially destructive? One reason is because it may limit financial flexibility. Individuals who are deep in debt may have less opportunity to put aside money for long-term financial goals. Every dollar that must go toward paying down debt is a dollar that can’t be saved and invested for retirement or a child’s college education.
Another reason is the sheer cost. Debt, of course, incurs an expense. Whenever you borrow money, you not only have to pay back what you borrowed, but you have to pay interest on the money as well. If not repaid promptly, the interest can add up over time and eventually even exceed the original amount of the debt.
Different kinds of debt usually carry different amounts of interest. At one end of the spectrum are relatively low-interest forms of debt – currently home mortgages and home equity lines of credit are one example. High-interest debt at the other end of the spectrum may include credit cards and short-term consumer loans (sometimes called “payday loans”).
“Good” versus “bad” debt
Is there such a thing as “good” debt? Some financial planning experts would say yes and point primarily to home mortgages and/or home equity loans. The interest rates on this kind of debt tend to be relatively low, and in some instances, this debt may be tax-deductible, which may reduce the effective interest rate that is paid.
Also, debt that is paid on a home mortgage is going toward an asset that may increase in value (or appreciate) over the long term. Conversely, debt that is paid on an auto loan is going toward an asset that is more likely to decrease in value over time.
Therefore, when it comes to debt reduction strategies, many financial planning experts recommend eliminating high-interest debt first. This usually includes credit cards and other types of consumer loans (for example, payday loans and some auto loans). Once these types of debt have been repaid, it may then make sense to concentrate on paying off lower-interest debt.
Here are three suggestions to help you avoid falling into the debt trap:
1. Shred your credit cards. This may sound extreme, but if it’s hard for you to resist using credit cards excessively, it may be wise. Another idea is to literally put your credit cards “on ice” by freezing them in a bowl of water. Then you’ll have to wait for them to thaw out, during which time you may be able to fight off the urge to use them.
2. Pay cash for purchases or use a debit card. With your credit cards shredded or on ice, you’ll have to pay for purchases with cash or a debit card. This may help you build financial discipline and buy only what you can afford right now.
3. Avoid impulse purchases. Whether shopping at the mall, the grocery store or online, make yourself think twice (or three or four times) before buying things you don’t really need.