There are many debt traps with long-lasting effects, some that could take years to recover. Here are a few often overlooked debt traps that you should always avoid:
Paying off credit cards is a topic widely covered on the Internet, as well as thousands of self-help books, online courses, credit repair and debt counseling services. Everyone has advice on how to pay off credit cards, and they all start with the same concept – pay off higher rate cards first, then lower cards. However, the issue is not the order in which they should be paid, but the reason they were overused. Before you come up with a plan to pay down your debt, look introspectively into why you got into debt, and how you’ll avoid debt in the future. I’ve seen many people celebrate going debt-free only to find themselves in just as much debt or more 5 years later. It’s often because life events and unexpected expenses took over.
While payday loans can be a lifesaver for some families, they come with some of the highest rates. You could end up paying 20% or more per month on the loan, which will add up very fast.
A brand new shiny black convertible sounds like a car we’d all love to have. That convertible you want might cost $40,000, and even if you put down 20%, you’ll be looking at a $600/month car payment. If you decide to sell or trade it in just a few years, it won’t be worth $20,000, so be careful spending big money on cars. Quality transportation can be found for $10-12k, and brand new quality cars can be bought for under $20,000. Until you can pay cash for that $40,000 convertible, buy a lower priced car and save $300/month on car payments.
The advice my grandparents gave my father was to buy the most house you could afford, because it will be easier to pay it off over time. While that may have been true in the 1970s, today’s housing market is not consistent enough to use as a long-term investment. For example, if you make $60,000 and your affordability is $250,000, don’t spend it all. Buy a home that’s 70-80% of your affordability, about $200k, so that you can afford all that life has to throw your way. The extra $250/month you’ll save will go a long way. If you don’t need it, you can save the extra $3000/year.
Student loans is a topic that cannot be covered in a single paragraph, but the most important rule is: never take out student loans to cover living expenses. You will end up spending twice as much over the loan for things like rent and food, of which have no return on investment. These costs can be avoided by attending schools within commutable range for at least the first two years. As long as you finish your degree at a university, the first couple of years aren’t nearly as important.
Of all the debt traps, this is the worst of them all. Grandma co-signs her grandson’s new car loan and he only makes the first couple of payments. Mom and dad bail out a newly divorced parent with an apartment they cannot afford. These situations arise out of love and empathy but end in fear and frustration. Debt collectors are as friendly as a lion and have heard every story you could imagine. Never, ever co-sign a loan. As long as you live by that rule, you’ll never have to deal with the frustration.