Debt can be a slippery slope. Some types (like mortgages) are healthy and improve your ability to do and buy the good things in life. Others (like, um, that sofa you’re still paying off) should come with a “danger” warning before you sign on the dotted line. Here, four types of debt that could spell disaster if you’re not careful.
The Four Types of Debt You Should Never Take On if You Can Help It
1. Credit Card Debt
The average amount of credit card debt for families who carry a balance is $9,333, according to Value Penguin. Even more staggering is the fact that the average credit card interest rate is 14.58 percent for existing customers. (It’s 17.98 percent for new offers.) Here’s the rub: Credit card debt makes it almost impossible to build wealth because, no matter how much you pay off each month, if you’re not covering your balance in full, the interest charges alone are enough to cut any progress in half.
Yes, there’s the allure of strategizing around points and cash back. But the minute you start carrying a balance, any potential for financial gains goes out the window. (Just look at the section of your statement each month to get a sense of how your interest payments add up, especially if you only make the minimum payment.)
2. Payday Loans
If you're living paycheck to paycheck, payday loans can seem appealing, given that they basically allow you to get cash immediately. But this type of loan is another form of debt that can get you into hot water fast.
For one thing, you’re going to want to read the fine print. There’s a hefty interest rate assessed on the date payment comes due and if you can’t meet that date, the interest rate goes up…and up. In fact, the average payday loan comes with fees ranging from 10 to 30 percent on every $100 they loan you…and that’s only if you pay it back on time, according to Dave Ramsey.com. In addition, payday loans aren’t something you can escape or easily punt down the road. When you take one out, in most cases, you’re giving the lender direct access to your checking account, which means they’ll be recouping the funds, whether you can afford it or not.
An alternative if you're strapped for cash? Consider setting up a lending circle with friends, where each participant contributes a set amount of money each month with the “pot” going to one person on a rotating basis to help the party most in need. (There are even sites that help you automate it as a way to build better credit.) But you could also approach a credit union about a “payday alternative loan,” which comes with higher-than-typical interest, but is granted to those with bad credit and generally has a more flexible repayment plan. One more option: Negotiate with the person you owe money to. COVID has presented a world-wide crisis, which has put the pressure on for institutions—think medical offices, banks, whoever issued your car loan—to be a bit more flexible. Bottom line: It never hurts to ask.
3. Rent-to-Own Plans
A rent-to-own plan is an agreement that allows you to pay for something—most commonly consumer goods, but also property—in installments with the option to purchase at some point in the future. But, as tempting it is to walk out of a store with something you couldn’t afford (like that washing machine you had to have) it’s really not a sound financial move, and could end up costing you more long-term. Often, rent-to-own agreements leave you paying monthly installments that amount to more than the cost of the item if you were to pay for it in full up-front. There also tend to be hefty fees assessed on late payments, no protection or financial help with repairs and a number of hidden or added costs you might not notice right off the bat.
A better bet? Stick to items within your budget. Or buy second hand—there’s so much cute stuff out there, and it’s better for the environment.
4. Personal Loans
Before you consider a personal loan, think about your reasons for taking one out. If you’re aiming to get yourself out from underneath a mountain of credit card debt and can consolidate your cards into one lower monthly payment, this type of loan may be advantageous. But if you’re doing it to pay for something you can’t currently afford—say, a new TV or the cost of a wedding venue—think again. The interest rates may not be as high as a credit card’s, but they’re not far off. (Also, beware if you have bad credit — interest rates tend to be higher based on your score.) Even worse, personal loans come with processing fees and a non-negotiable fixed monthly payment. If you miss a cycle or fall short, the repercussions could include a lawsuit. Not worth it.