Debt may very well be a four letter word in your house that you choose to ignore as much as possible, but the more you understand about your options in how to manage debt, the more control you have.
Here are four common debt misunderstandings, and why separating fact from fiction can change the direction of your financial life:
1. Taking baby steps to reduce credit card balances
If you assume the only way to pay down credit card balances is paying whatever money you have left at the end of each month toward debt, you’re missing a potential opportunity to get more aggressive in your debt reduction strategy.
Peer-to-peer lending sites like LendingClub have become a popular alternative for borrowing money at more competitive rates than traditional financial institutions offer.[pull_quote align=”left”]Peer-to-peer lending sites pair investors who have money to loan with borrowers who need money for reasons including funding a business, improving a home, or paying off debts.[/pull_quote]By pairing investors who have money to loan with borrowers who need money for reasons including funding a business, improving a home, or paying off debts, the concept is as a win-win. Those who loan money get higher rates than stock markets traditionally yield, and borrowers get lower rates than banks offer.
The sites have become a haven of sorts for those with credit card debt. In a phone interview, LendingClub chief marketing officer Scott Sanborn said that the average LendingClub borrower has a credit score of about 716, an established credit history that spans about 14 years, and an average income of about $69,000.
Yet, as many as 70% of LendingClub borrowers seek loans to pay off high interest credit card balances that they accumulated in their younger years.
Average rates to borrow from either site start at about 6.5%, but like a traditional loan, you’ll pay higher rates if you’re a higher risk borrower.
2. Assuming ‘good debt’ doesn’t need to be paid off
Major purchases like buying a home, paying for college, and even financing a car (depending on how long you intend to keep it) are often referred to as “good debts,” because they have long-term value.
By contrast, “bad debt” includes credit card balances, auto leases, and anything that ends up costing you more than the item is ultimately worth.
The danger behind the connotations, however, is the misunderstanding they evoke. In truth, no debt is good when you are trying to build wealth. If you own a house, your strategy might include staying in it for the long-term, or taking on a shorter-term loan, so that you’ll pay less interest, and own it outright sooner, versus selling and upgrading every few years.
Likewise with students loans: Even a low 3.4% fixed rate Stafford loan is costing you money that you could be saving, or investing, to build for the wealth long-term.