Debt

(Proverbs 22:7) the borrower is slave to the lender.

Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase.

There are two types of debt: secured and unsecured.

Secured debt means the borrower has put up an asset as collateral for the loan. Auto loans and mortgages are common examples of secured debt. If you fail to repay as agreed, the creditor can seize the asset, for instance repossessing a car or foreclosing on a house.

Unsecured debt is not backed by an asset. A common example is credit card debt and payday loans. That doesn’t mean you don’t have to repay. A credit card issuer, for instance, will likely sell your delinquent debt to a third-party debt collector, and they will then hound you for payment. If you don’t pay the debt collector, they could sue you for payment, which can lead to wage garnishment.

Good vs. bad debt. What’s the difference?

A simple rule is if it increases your cash flow, it’s good debt. If it doesn’t do that and you don’t have cash to pay for it, it’s bad debt. I know, many people, websites, and financial advisors will try to tell you that a mortgage is good debt because it increases your net worth, but nobody can guarantee the value of what is mortgaged will go up. Think 2008.

How do you know you have too much debt? If you have 2+ jobs and one of them is selling your blood plasma or dancing with a pole for a partner. A more accurate way is your debt-to-income ratio.

Add up all your monthly debt payments and divide them by your monthly gross income to get your debt-to-income ratio. For example, you have a $1,500 mortgage, $300 car payment and pay $200 per month for credit cards, your monthly debt is $2,000.

With a monthly income of $4,000 that makes your debt-to-income ratio 50%. Anything higher than 43% debt-to-income ratio is a red flag to potential lenders. Borrowers with a high ratio are more likely to have problems making monthly payments. In most cases, you can’t qualify for a mortgage if your ratio is over 43%.

So paying off bad debt is in your best interest. There are dozens of ways to accomplish this and everyone has an opinion to which one is better. Some include paying off the lowest balance first (Debt Snowball), paying off highest interest rate first (Ladder Method) or paying off the one with the lowest Cash Flow Index first. (Balance divided by Payment= CFI). An internet search will give all kinds of options, variations there of and why that way is the best.

It doesn’t really matter which way you do it, the most important thing is that you do it. Try them all and find the one that works best for you and unless you’re a numbers nerd, keep it simple, because that’s the one you will keep doing.

Also stop using bad debt and live within your means otherwise you will not get ahead of it. Yes, that means closing those accounts and cutting up those cards. You won’t believe how much better you will sleep when you win this.

You can do this. You NEED to do this for your family, for your dreams and your goals.

Let me know what you think or if you have questions.

Stay Loose