Types of Debt And Which Ones To Avoid
Have you ever wondered why there is so much mixed information out there on the internet about money, finance, and debt? Which debt is bad? Which is good? The answer may surprise you.
There are many types of debt out there, and some of which you need to downright avoid.
In the next several sentences I’m going to share with you the 3 types of debt you need to avoid at all cost, the types of debt that are ok, and some strategies to fund your lifestyle without debt.
First, lets start out by defining debt
Merriam Webster’s definition of debt is:
Lets use the 3rd term as our point of reference. To be under obligation to pay or repay someone or something in return for something received, a state of owing.
So with this definition in mind it’s easy to see that there are in fact good and bad types of debt.
Debt that is owed that brings no inherent value or perceived value with it can be considered “bad” debt, and debt that brings inherent value “good” debt
So What Are Some “Not so Good” Types of Debt
Debt #1: Credit Card Debt
As I’m sure you may know by now, if you’ve read my site for any period of time, I am completely opposed to having any credit card debt.
Personally I have a zero balance on all but one credit card which I treat as a 0% loan to myself. I recently gave up using my credit card for day to day spending, to learn why check out Why I Gave Up Using My Rewards Credit Cards for Everyday Purchases?
Outside of big purchases I no longer use my credit cards for day to day spending.
I still do use cards with 24 month grace periods because it free’s up my capital for investing activities, allows me to keep a sizable emergency fund, and allows me to breath easier knowing that I could get equipment I need for my business without worrying about not being able to pay my rent because I spent all my liquid assets.
With your own business you will be able to take the expenses you incur purchasing capital goods, like machinery, computers, or other assets, but be careful not to spend all the money your business is making otherwise you could put yourself between a rock and a hard place should your lenders ask for the funds promptly.
With that being said, here are my rules for having and using a credit card:
- Never carry a balance unless it is on a card with no interest for a deferred period of time, AND you have a repayment plan in place for it (ex. 15 months 0% with $X paid each month to fund the cost of _____ )
- Expenses are for capital purchases or business related expenses.
- Coffee and dinner dates, unless they are seriously with clients should be avoided.
- Have the funds saved in your business checking or savings account, or have the cashflow already flowing into your business, to cover your expenses.
To learn how I used travel credit cards, for free, check out my article: How I used Travel Rewards Credit Cards For FREE…
Someone just getting started in business though need not spend money they don’t have on credit cards in “hopes” of a return. If you can’t start incredibly small and roll the profit into greater returns rethink your business model and/or business plan.
If you need money now, get a job and save at least 6 months in emergency funds before you try to start your own business.
Credit cards are a terrible thing to use for your luxuries like clothes, jewelry, and anything else that does not produce income.
If the item does not product income for you, I recommend not buying it with credit. Instead buy it with money you saved from your income (preferably passive income).
Debt #2: Student Loan Debt
I am personally a believer that school is really the last resort when it comes to furthering yourself.
I had to pay back over $33,555 in student loan and credit card debt so I know that there are better ways to grow your income than studying for 4 years to get a degree in something you may or may not use.
With that being said, I can think of at least 20+ different ways to finance your own education in life:
- Work your way through school by getting a part time job
- Work your way through school by starting your own summer business
- Get a technical job instead
- Work for a small business owner locally
- Get Adwords certified
- Social media marketing manager
- Learn Affiliate marketing
- Look on craigslist a need and fulfill it
- iTunes University
- Start a lawn care business
- Start a dent removal business
- Start a window washing business
- Start a dog walking business
- Become a Nanny
- Look at becoming an Au Pair
- Go teach English abroad
- Teach English as a second language locally
- become a sign language interpreter
- write a blog
- learn email marketing
the list just goes on an on…
And of course if you are still interested in going to college you can look at grants, scholarships (both domestic and abroad) and consider community college or online degrees instead of attending full time university.
If you are one of the fortunate ones who has parents paying their way then take advantage of every opportunity you get in college to further your social network, your education, and your relevant professional experience.
There is no reason you should be coming out of college with any more than $10,000 in debt with all the possibilities out there.
If a white kid like me can go to school, come out with only $27,000 in student loans after attending a school with tuition costs of $176,000 for 4 years, with financial support from his parents, and work his way out of debt in only 3 years, then you can find a way to get funding to cover your full cost of education.
Individuals located outside of the united states have even more options for education with a lower cost of tuition.
Should you find yourself choosing to attend university, consider studying abroad in countries like Germany, Canada, United Kingdom, Hong Kong, or Singapore where the tuition is as little as 10% that of a school in the United States.
Debt #3: Mortgage Debt
This debt is one in which folks typically incur in order to purchase the “home of their dreams”, which can later become a nightmare…
Firstly, with an asset that will more than likely depreciate if you are buying anything other than in a neighborhood with millionaires in it, this is probably one of the least valuable assets you can invest in.
In addition to the likely depreciation that you will pay for a new home, you have variety of interest rates to play with, 15 year, 30 year, fixed mortgage, variable interest rate mortgages. There is also the question “how much should we put down as a down payment?” The answer? As much as you can afford.
Really REITS are the way to go if you are looking to invest. If you are looking to simply live in a place then consider renting.
I always aim for living in a place that is close to 10% or under my take home pay.
When I was earning $25,000 a year, I had to live at home to afford to pay my loans back and to be able to eat, pay rent and live. I contributed around $300 a month for food and living arrangements, and by my dad’s good graces was able to afford living.
Once I got a better job and earned more income I increased my rent contribution and eventually moved out to live with a room mate in a small 2 bedroom 1 bath apartment.
Then I got yet another job paying more and was able to move with my girlfriend to an apartment across from work. Still, keeping my housing costs as low as possible, ideally around 10% of my before tax income.
If you are looking to own a home now a days, money experts the likes of Tony Robbins, Dave Ramsey, and Grant Cardone suggest investing in REIT’s and Saving for your first investment property.
Check out this Article on CNBC Money: https://www.cnbc.com/2017/04/25/heres-how-much-money-the-average-first-time-home-buyer-makes.html
Don’t look to own a home.
But if you are still interested in owning a home, increase your income first to where your payment will be around, or under, 10% of your take home pay.
Want a $300,000 home with a 30 year mortgage and $1,000+ mortgage payment? Earn 10x that before you look at buying.
Being evicted from an apartment is a much smaller blow than losing your house and all the money you sunk into financing it.
Avoid mortgage debt at all costs until you can afford to buy your home or you at least earn 10x your mortgage payment.
Debt #4: Small Business Loan Debt
If you have a valuable good or service, that has been thoroughly researched and has been validated in the marketplace through small batch testing, then do you really need a loan?
I’m thinking not.
If you have a product or service which is consistently selling out and you need more capital to purchase more inventory that could make sense to invest.
One of my favorite ways to Microfinance a business, in order to minimize the risk but maximize the upside, is to get a 0% credit card like the chase freedom card, and to spend at most 10% of the credit maximum on business essentials. That means finding a good or service that is needed in the market place and to invest up to 10% of your card limit before calling it quits.
If you’ve followed the 6 Steps I’ve outlined in “6 Steps to Financial Freedom” and you’ve paid off all your personal debts, consumer debts, and student loan debts, you are now ready to begin building a business.
If you are approved for say $6,500 credit limit with a 0% APR for the first 15 months and you spend at most 10% of the card limit to begin your business you can, at any given point, afford to pay off the full balance. Carrying this $650 startup cost for up to 14 months before needing to pay it back is an option, but should you actually find a product or service with a need in the market place and be able to sell it for at least a 50% profit you will be able to reinvest the profit to not only pay off the full balance, but be able to then take the $650 that you have in profit and use that moving forward.
The important thing is that you take the profits each month and pay off the FULL balance of the card before you pay anything else. You do not want to carry a balance.
I REPEAT. YOU DO NOT WANT TO CARRY A BALANCE.
All the fund that your business spends you can funnel through the credit card each month, but you will keep a separate business checking account and not spend a penny of that money on your own personal expenses.
This money, just like a tree, needs to grow and not be “picked” like the fruit on an apple or pear tree. If you pick fruit before it’s ready you can kill the tree and it will taste like shitty fruit.
With that being said. Following that process you can quickly scale up and know that you have a value-able service or good without sinking your life savings into it.
What are Some “Better Types” of Debt
Type A: No Interest Personal Loan to Pay Off High Interest Debt
A personal loan from a friend or family member that know’s and trusts you, doesn’t need the money immediately, and can afford to live with out. Using this money for anything other than to pay down high interest credit card debt or student loan debt is a TERRIBLE choice and WILL result in you failing and getting into more debt.
Do NOT buy a car with this. Do NOT spend it on clothes. Do NOT frivolously blow it on the weekend. This is a personal loan that will help you to save thousands on interest by paying your high interest debt back early.
Type B: Personal Loan From Yourself to Yourself
If you have a decent savings account and you are trying to pay off a high interest debt that you occurred due to a bad business decision, or to start up your business venture, then consider taking out a personal loan for yourself. Key here is to set an expected payback date that you will 100% meet.
There is no point in loaning yourself money that you do not intend to pay back. You might as well just not do the loan and instead figure out some other way of funding the payoff of your 19% debt to the bank or your 6-9% interest on your student loans.
Type C: Private Loan to Aquire Cash Producing Assets
As Robert Kiosake writes about in his Rich Dad Poor Dad books, taking out a small loan from a friend or a family member, with the expectation to pay it back with around 10% interest, could be a valid option for acquiring real estate assets in the short term.
The tricky part here is that you have to know what you are doing to minimize your risk and to maximize upside for you and your investor.
This strategy is in the event that you have no liquid assets to use to invest in your first short term flip. But for those individuals who are interested in this avenue, securing financing from a friend or family member in a small investment around $2,000 (depending on your market), could be a good seed money to begin buying and selling real estate.
This method can be a bit risky though and is probably a better option for those a bit more risk tolerant.
For individuals who are less risk tolerant you would be better off growing the investment through a diversified asset like an REIT (real estate investment trust) and then reinvesting the money in a property once it’s reached a $5,000 mark.
With that property though, understand that there is quite a bit of work involved to find the tenants, maintain the property, collect the rent, and possibly even evict the tenants should they fail to pay.
Once you reach the $5,000 mark you can elect to simply keep your funds in the REIT and allow them to continue to grow at the market rate so as to not have to worry about the difficulties that come with managing properties.
How to fund your lifestyle without debt
Option 1: Start a blog
Option 2: Develop a unique skill and market and sell it
Option 3: Find a unique problem in the market place and sell and market that
Option 4: Begin investing your spare income (this isn’t really an option this should be viewed more of as a must in my humble opinion)
Option 5: Get a membership to Audible for $16 bucks a month and listen to a new book on business each month.
Option 6: Subscribe to free podcast on any subject you are interested in.
Option 7: Attend university level courses on your iPhone or iPad through iTunes U.
Option 8: Become a computer programmer on the weekends using W3 schools.
Option 9: quit life and live as a hermit in the woods eating squirrels and berries for survival
Ok the last option is more of a joke but you get the point. There are many ways of funding your ideal lifestyle but they all pretty much involve learning new skills and ways of managing your time and money moving into the future.
“If you want to live, and give, like no one else, then you have to be willing to live like no one else” -Dave Ramsey –
You really don’t need to go into debt to begin building wealth, you can start doing that working at a subway shop or a pizza shop. What you need moving into the future is new skills and knowledge, all of which you can gain through this magic called the internet and through networking with other entrepreneurial thinkers.
- You don’t need to go to school to make a life of your dreams.
- If you do, avoid getting into debt, there are numerous ways to fund education.
- Avoid getting into debt with credit cards and carrying a balance.
- Avoid buying a home without substantial assets, and research the area you are buying in to look for market upswing.
- Don’t take out a small business loan, start small instead and reinvest the profit.
- Acceptable forms of debt include debt which has a lower interest rate (or preferably no interest rate) to pay off higher interest rate debt (5%+)
- Personal loans from friends or family are a good way to begin investing, start small and turn a profit, pay them back, and reinvest the profits.
The possibilities are endless and you don’t need to subscribe to any one persons “plan for life” in order to live a life of your dreams.
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