Debt is often compared to a prison. And, truly, debt can be a financial prison. Consider: When you are in debt, you are in a cycle of paying interest to someone else. This is money that is not used for your good, but rather goes straight into someone else’s pocket. And, because of the nature of interest, it doesn’t reduce your principal, so you owe money for longer, meaning that you aren’t free to use your money as you would like to improve your lifestyle.
As you consider your money decisions, realize that there are some debt traps that can keep you in a cycle of living paycheck to paycheck, and not having much disposable income or time. Here are 5 debt traps to avoid:
1. Payday Loans
This first debt trap is rather obvious. Payday loans, especially if you get caught in the cycle of renewing them, can be quite expensive. Payday loans are known for their high fees. And, while you might emerge relatively unscathed if you use a payday loan once and pay it off, the real trap comes as you renew, paying between $10 and $30 every two weeks just to keep it going, while making no real progress on reducing your debt.
2. Maxing Out Your Credit Cards – And Paying Only the Minimum
When you pay only the minimum payment on a maxed out credit card, you pay quite a bit of interest, and the principal is reduced at a snail’s pace. And, of course, if you close to the limit, it’s easy to go over and incur further fees, increasing your debt, and making the credit card even harder to pay off. Do your best to avoid maxing out your credit card; only spend money you have so you pay the balance off each month. If you are stuck with credit card debt and need a do-over, then consider transferring your credit card balance to a 0% interest credit card so you can save money on interest. Just make it a priority to stop using your credit cards for new purchases, and pay off your balance ASAP.
3. Too Much House
It’s tempting to get a mortgage for what a bank will approve you for. Indeed, I was approved for two times the amount of my current mortgage when I applied. While we could have handled the payments, they would have represented 35% of our monthly income at the time. Just because you can make a house payment doesn’t mean that you should get a big mortgage — especially if you have to stretch to make it work. You will be house poor, and perhaps be one financial setback away from catastrophe. Along with this is over-improving your home. Most home improvements don’t increase your home’s value enough to cover their cost, so it makes sense to go slow.
4. Going Crazy with the Student Loans
I’m guilty of this. I didn’t even need student loans during my undergraduate career. However, they were available, so I took out the max. Going crazy with the student loans is one way to saddle yourself with debt, especially if you go to an expensive school. Carefully consider what your education is worth, and consider the cost of paying down student loans. If you do need student loans to help you make ends meet, borrow as little as possible and pay it off as soon as you can.
5. Co-Signing on a Loan
You might want to do your friend, or a family member, a favor by co-signing on a loan. Unfortunately, once you co-sign, you are on the hook for the debt. If the borrower doesn’t pay off the loan, or make payments as agreed, the creditor can come after you. My in-laws were burned in this way before; they co-signed on a loan, and the borrower didn’t come through. Their credit suffered a major setback, and they had to repay the loan. Be extremely careful before you sign the dotted line; make sure you truly trust someone before co-signing — and even then think twice.