Beware of the Debt Trap

Debt is a common fact of life in America today. According to a recent report from the Pew Charitable Trusts, roughly eight out of ten Americans have debts that average $67,900 per person. Debt can be both good and bad. Good debt is a useful financial tool, helping you to do things that will improve your finances in the long run – such as going to college, buying a home, or building a business. By contrast, bad debt, such as credit card debt, just weighs you down with interest payments while doing nothing to increase wealth. Debt is a serious threat to your financial security because it keeps you from making the most of your money. Whenever you take out a loan or charge something on a credit card, you’re simply borrowing from your future income. So, the $1,000 or $100,000 you spend today will be taken from what you earn in the days to come. What you spend on debt payments could be used to grow your emergency savings, for your retirement, or your kids’ college education. Eliminating debt is an important first step toward a healthy financial future.

Below are six great reasons why it is important to eliminate debt:

More Free Income. When you’re carrying a lot of debt, the payments on that debt tie up a large amount of your income. For instance, suppose you have a 30-year mortgage for $200,000 at 4.5% interest. The payments on that mortgage will eat up $1,013 of your income each and every month – and nearly half of that will go toward interest, not building actual equity in the house. If you are able to pay off that debt early, suddenly you’ll have more than $1,000 of extra income available every month. That’s more than $12,000 each year that you could spend on the things that matter most to you. With the extra money you save by paying off your debt, you could put toward retirement, investments, or other financial priorities.

2. Less Risk. One of the worst things about being in debt is the risk it brings into your life. If you’re already in debt and have no emergency savings to fall back on, you’re always just one financial blow away from disaster. A job loss or a major medical crisis could leave you unable to meet the payments on your debt, which could result in:

Constant calls from collections agencies
Being sued for nonpayment, and possibly having your wages garnished
Having your car repossessed
Losing your home due to foreclosure or being evicted because you can’t pay your rent
Bankruptcy

Being debt-free removes these risks. It gives your budget room to breathe so you don’t have to worry about a single unfortunate event ruining your financial and personal life.

3. A Better Credit Score. Carrying a lot of debt negatively impacts your credit rating. The closer your credit cards and loans are to the limit, the lower your credit score will be. A bad credit score can cost you thousands of dollars a year in higher interest rates, making it harder to get out of debt. The flip side is that as you pay off your debt, your credit score will improve. This, in turn, can offer a wide range of potential benefits:

Better interest rates on any future loans
Lower insurance premiums
Better employment opportunities, since employers often check credit scores to see if a potential employee is reliable
A better chance of finding an apartment, since landlords sometimes do the same
Better deals on cell phone and other services

4. Less Stress. Living with debt is a major source of stress. You constantly worry about how you’re going to pay your bills and what could happen if you lose your job. The constant pressure of having to work to pay off debt, while feeling guilty about spending on even the smallest of pleasures, grinds you down. A recent study at Northwestern University found that young adults (aged 24 to 32) with high levels of debt report overall stress levels about 12% higher than the average. Being in debt was rated more stressful than losing your job, getting a divorce, or becoming temporarily homeless. Getting rid of debt is like lifting a huge weight off your chest. And, with your thoughts no longer locked into the constant pattern of worrying about money, you can devote more energy to work, family, friends, and pastimes you enjoy.

5. Being Able to Help Others. Getting out of debt has one more big benefit — It makes it possible for you to help others. If you have family or friends struggling with debt, you can help them as well as share your debt elimination success story to inspire others to tackle their own financial problems. Additionally, being debt-free allows you to give money to charity. Happiness economists have found that spending money to help others is one of the most rewarding things you can do. It’s a great feeling to know your money is helping to make the world a better place.

This article is a part of a series:

Don’t just work for money, make your money work for you … Invest!

2020 Reminded Us Everyone Needs Life Insurance

Why it is Important to Have Emergency Savings

Starting the New Year with a Legacy Wealth Budget