Financial Education

3 Types Of Debt And How To Avoid Them

October 21, 2020

Almost everyone you meet these days has some kind of debt.  Even if someone doesn’t have any kind of debt, it’s pretty fair to assume they will in their future.  This is not necessarily because of any mismanagement of finances, but just because people rarely have the required cash on hand to purchase, say, a house.  

Each of these categories can (and likely will) be expanded upon and given their own article.  Here, we’re barely going to scratch the surface of these areas and merely provide an introduction.    

Credit Card Debt

It is an unfortunate fact of life that owning and using a credit card to build up a credit score is necessary if you ever want to take out a loan through a bank.  At the start of 2020, there was over 1 trillion dollars in national debt.  That’s an average of over $6,000 per person (per person regardless of if they actually have any credit card debt or not).  

There are several private companies that allow you to take out loans without submitting a credit score, but we can cover them in another post.  

However, many people take their credit card limit as permission to spend money they don’t actually have.  “It’s a way to buy things and not have to pay for it until later!” sure, but you still have to pay for it, and the longer you wait the more expensive it ends up being.  Interest accumulates on credit card debt.  A $200 pair of shoes could end up actually costing you $231 and taking you 2 years to pay off, and that’s only if you have a good credit score!

Sure, an extra $31 doesn’t sound like a whole lot, especially spread over 2 years.  But that’s not all you’re putting on there, is it?

Let’s say you have $3,000 worth of debt on your card.  With the exact same numbers I used to calculate the cost of the shoes above, you will end up paying an extra $2,000 over the course of 14 years.  14 years is a long time, but $2,000 is nothing to roll your eyes at, especially when you consider it’s exactly two thirds of the original balance.

How much you owe depends on your credit card company, your credit history, credit score, how much you pay on your debt each month, and so on.  

Sometimes, you may notice that your credit card company will increase your credit limit.  This usually means you’ve done a good job of paying your bills on time.  Personally, I’ve had my credit limit increased a few times because I always pay on time and I always pay the full amount, so I have no debt.  While I’m grateful and feel like I’ve earned a little pat on the back, I’m also wary and wonder in a conspiracy-theorist-like manner if they’re just trying to trick me into spending more and not paying off the full amount every time.

Don’t fall for the tricks.  Pay off your balance in full and don’t spend money you don’t have in your bank account!

Student Loan Debt

As of June 2019, the national student loan debt was estimated to be around $1.6 trillion.

Once upon a time, if a young person wanted to go to college, they had to go to their banks to apply for a loan to pay for tuition.  Since the bank is essentially a business, they had motivation to take every precaution they could to make sure the loan could eventually be paid off.  One of the things they did was look at the area the applicant wanted to go into.  Those looking to go into a higher-paying field were more likely to receive the loan.  Those who were not, were less so.  Since loans were taken through banks, this also meant bankruptcy could be filed.  Bankruptcy was not good for neither bank nor school, because neither would get their money.  Because of this system, colleges were motivated to keep tuition low and banks were more motivated to only give loans to those who were going into a profitable field.  

The United States government shifted the system by using government funds (taxes) to fund student loans.  Because it was a government loan, students could no longer file for bankruptcy.  This means these loans must be paid back.  

It is possible to get student loan debt forgiven, but you have to be able to prove the debt will impose “undue hardship” on yourself and those who depend on you financially.  Here is an article discussing how you might avoid paying back student loans, but it’s clear throughout it’s incredibly difficult to achieve.

Therefore, colleges had no incentive to keep costs low, and banks no longer even had the ability to vet college applicants.  Federal student loans are made directly to the student and the only requirements they must meet to qualify essentially boil down to being a United States citizen, having a high school diploma, and not completely slacking off in school.

The national debt has raised significantly since this change in 1965.  Between inflation and this unlimited access to student loans, debt has skyrocketed.  Last year, students graduated with an average of over $30,000 in student loans.  That doesn’t even include the debt their parents may have taken out for them.

If you choose to go to college for medicine, engineering, or anything that genuinely requires a degree, then by all means go for it!  Especially if it will ultimately pay well.  However, consider what can be done without a degree, whether it be online or through a mentor.  Programs like Praxis and Lambda School are great alternatives for kicking off a career with little to no debt.  And if you do ultimately decide to follow through with college, pay as much as you can upfront and then pay it off as quickly as you can to avoid accruing interest.

Auto Debt

In the beginning of 2020, national auto debt rose to $1.2 trillion, making up about 10% of all household debt.  At the end of 2018, the average auto loan debt was a little over $32,000.  

Possibly the easiest way to avoid debt, especially with a car, is to buy a used car and pay the full amount in cash.  It’s important to remember when buying a new car, as soon as you drive your purchase off the lot, the value of that “new car” drops by at least 9%.  In the years following, the value of your car will drop by at least 10% per year.  However, the car doesn’t necessarily run any worse, though the value of the car will also decrease depending on mileage and damage.  

Refrain from buying brand-new cars.  Even if there is a new car you really want, you can get it far cheaper the following year when the dealership is getting ready to bring in the newest models and need to get rid of last year’s inventory.  Or, you can simply buy a used car for a few thousand dollars, pay it off in whole, and avoid the debt completely.

This is a chart from Dave Ramsey’s website showing the value depreciation of a new car over 5 years.

If you do choose to buy a car brand-new, it’s best to pay as much as you can upfront, then pay off the rest as quickly as possible.  Similar to credit card debt, the interest accrued will drive up the overall cost of the car and at the end of the day you’ll be paying even more for a car that’s already losing value rapidly.  

Like mentioned earlier, each of these could be easily turned into its own blog post (or multiple).  Debt often cannot be avoided, but it and its negative effects can be minimized.

There is so much to cover in personal finance, and at Digifox we don’t want to stick purely to crypto.  We’re going to be diving into more traditional financial topics and this is just a taste of what it’s going to look like!

Digifox is an all-in-one finance platform. Earn 50-100x more on your interest, buy crypto, and send money globally.

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