Knowing The Differences
Between Good, Neutral And Toxic Loans Will Help You Get Out Of Debt
By Michael Redbourn
The two most popular approaches to debt settlement right now are the snowball system, which basically means paying off the creditor to whom you owe the least amount of money to first, and the avalanche system which means paying off the creditor that's charging you the highest amount of interest first.
Snowflaking can be used with either of the above systems, and in essence, it means cutting back on your day to day expenses wherever and wherever you can, and even if you just save $10 by not eating out, you mail the money the same day, or the same week to the creditor that you're trying to pay off first.
Something that none of the above systems mention is categorizing your debts into what you might want to call, good, neutral and toxic, and well take a look at what that means, and how to do it now.
What Is A Good Debt?
Many people will tell you that all debt is bad, but they'd be wrong, and the following are just three examples of "good debt".
1) A mortgage
The interest rates are always low compared with other loans, and in spite of the fact that many homes decreased in value over the last eighteen months, the long term trend is, and will be up, and anybody that holds onto a property for a good amount of time sees it rise in value.
2) Federal Student Loans
The interest rates are very low, and a better education should later prove to be a big bonus.
3) Some business Loans
It's of course possible to take out a business loan, only to see a business fail, but if you take one out and the business flourishes, then it should certainly be classified and a good debt.
When you look to see which of your loans should be paid off first, you should move all of your "good loans" to the bottom of your list.
What Is A Neutral Debt?
Examples of neutral debts would be,
1) A vehicle loan
2) Debt consolidation loans
3) Retirement plan loans
None of the above are what could be described as toxic debt, which well take a look at next, but none of them are "good debts" either, but before we talk about "toxic debt", let's fully understand what the term means.
Debt is deemed as toxic if any of the following are true,
The standard or default interest rate is in the double digits, or higher, which typically prolongs the time you remain in debt.
The lender is able to change its rates at will, with almost no grounds for doing so.
Initially very easy payment terms that encourage you to increase your debt to more than you can comfortably repay.
Toxic debts that you might have are,
1) Credit cards
2) Payday loans
3) Title loans
4) Pledges from pawnshops
5) Any high or variable rate loan
Toxic Debts Should Be Paid Off First!
If you were able to arrange an affordable repayment plan with a hospital or provider then it would be a neutral debt, but if you had sign up for a high interest loan, or are using a provider-supplied credit card to pay it off, then it's almost certainly a toxic debt.
Other Things To Consider
Maxed out, or near to maxed out credit cards should go near to the top of your list, because they will negatively affect your credit score and trigger higher interest rates from other lenders.
Try to keep all your credit card balances below 75%
If there's a chance that you might lose your job, then consider accelerating a retirement-plan loan, because most plans require you to pay back 401k and other retirement plans quickly after you stop work, and if you don't or can't do it, then the withdrawal will trigger a hefty tax bill.
You're almost certainly getting lots of tempting low interest credit card offers in the mail, and many of them will be well worth considering, but you should be very careful before you transfer a balance from one credit card to another.
The fees charged for balance transfers are quite high, and will normally increase the amount of debt by 3-4% so be sure to do the math and make sure that the lower interest rate will more than offset the fees.
What's more, many of these low interest offers are for fairly short amounts of time, so make sure that the interest isn't going to get hiked after just six months or so.
Finally, if you're feeling like you're losing the debt battle and need a little encouragement, then choose a really small debt and get it paid off quickly, and the satisfaction of crossing it off of your list, and perhaps tossing it into the trash, should provide you with a little bit of a lift, and hopefully give you the determination to soldier on.