Ways debt can hurt you
Debt, if used poorly, can have a very negative effect on your health, your finances, and your future.
Do you know the kinds of debt that are available to you? Do you know how debt can affect your life?
Knowing the answers to these two questions can put you on the path to success and improve your financial life.
So how does debt hurt you?
Negatively affects your health
- High blood pressure
- Anxiety
- Depression
- Lower immune system
- Neck pain
I’m no doctor, but I can tell you that debt has some seriously negative side effects to your health.
Ties up money
- Money you could save — Instead of paying, for example, $500 per month towards your debt, you could’ve been saving it. Say you it takes you 5 years to pay off your debt at $500 per month. After 5 years, you know what you end up with? $30,000.
- Money you could invest — Let’s continue the example from above. What if you invested that $500 per month in the stock market? The S&P 500, historically, returns about 9% per year. After 5 years, with total savings of $500 every month, you end up with almost $36,000. If you stop contributions after 5 years and let that money grow for 30 years, you come out with $477,000.
- Money for things you enjoy — Spending money on experiences has shown to have a greater impact on happiness than spending it on stuff. Either one, however, is better than wasting money on your debt.
Costs money
With debt comes interest. The bank, credit card, or lending institution charges you to borrow money in the form of interest payments. The level of the interest rate will depend on the type of debt.
Credit cards have a high-interest rate, with the average at about 15% Mortgages and auto loans usually come in pretty low, with the averages at 4.37% and 4.53%, respectively.
With each payment you make, a portion is directed towards the interest you owe on your card or loan. Over time, you will pay back much more than what you borrow.
For example, you take out a $200,000 30-year fixed rate mortgage at 4.5%. After 30 years, you will end up paying almost $385,000,
Impacts your credit score
Debt can have a very negative impact on your credit score. If you have to much credit being used, if you pay late, if you open up too many accounts, etc. All these things, among others, can hurt your score.
There are five things that impact your credit.
- Credit utilization — This is the amount of credit you have used compared to the amount of credit you have available. Shown as a percentage, the agencies want this number below 30%, but the lower the better.
- Payment history — Credit agencies want 100% on-time payments. Anything less than that will negatively impact your score.
- Derogatory remarks — If you have one or more of these, your score will reflect that. Derogatory marks are items in collections, tax liens, bankruptcies, etc.
- Credit age — The older age credit you have the better, so if you open new credit cards or get a loan, that lowers your credit age and will lower your score.
- Credit inquiries — Anytime you apply for a new credit account (i.e. loan, credit card, etc.) it shows up on your account as a hard inquiry. The more of these you have, the more it impacts your score. The lower the better.
The level of how much each item affects your score is listed below:
- Payment history — 35%
- Credit utilization — 30%
- Credit age — 15%
- Derogatory marks — 10%
- Credit inquiries — 10%
Types of bad debt
- Payday loans — A high-interest short-term loan taken out by an individual that’s to be paid back on next payday. The interest rate on these can be as high as 400%.
- Credit cards — Essentially a loan on a card. Usually the better your credit the higher limit you’re given. Credit cards also have high interest rates.
- Mortgage (more than was necessary) — Mortgage debt is used to buy housing. If you take out a mortgage for more than you can afford to pay, this will eventually bite you in the butt.
- Car loans — Taking a loan out on a depreciating asset isn’t the best of ideas. Buy what you need to get from A to B. Don’t spend lavishly.
- Borrowing from 401(k) — You can be eligible to borrow from you 401(k), it does vary by plan. However, if you borrow and are let go by that company, you will owe the balance of your loan within 60 days.
- Leverage — Leverage is most often used with investments. You can borrow money to increase the size of your invested position. This could backfire, however, if your desired investment goes backward, you could lose double your money or more.
Conclusion
Debt and how much of it you have can dramatically impact your finances. It can bankrupt you if you aren’t careful.
Being able to avoid it and/or use it effectively and efficiently is one of the big keys to conquering your financial life and set you up for success.
To learn more about debt and how it plays an impact in your life, and for our disclosures, go to www.crgfinancialservices.com or email me at jacob@crgfinancialservices.com.
Rates of return are hypothetical, are provided for illustrative purposes only, and do not reflect the performance of an actual investment.
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