3 Important Ways Debt Can Actually Help Your Finances
Imagine a country where everyone owns everything outright -- cars, houses, fishing boats, flat-screen TVs. There are no mortgages and nobalances in this imaginary land.
Does it sound like heaven? Perhaps. But maybe not.
For starters, everything would have to be paid for with money on hand. That would mean that unless you have a lot of money in the bank, then all the world's millionaires and billionaires would have easy pickings on the best cars, homes, education, or business ideas. You'd be forced to save and save until you had enough cash, and by then, most of the best opportunities to grow your wealth, knowledge, or career would be gone.
In short, debt -- used wisely -- can give you the power to take advantage of opportunities now, giving you a more equal playing field with your wealthier peers. More specifically, here are three reasons why debt can actually help your finances.
1. Good Debt Helps You Grow
Credit -- and the debt that follows -- lets people buy houses, invest in their business and make other purchases they couldn't have otherwise. The old saying, "It takes money to make money," still applies, and a bit of debt can help. They can buy supplies that can help them start their own home business. They can buy a home that they can start building equity in. They can send their kids to college.
And an economy that lets people buy things is a healthy economy. "Developed economies depend on the expansion of credit," said Daniel S. Hamermesh, a professor of economics at The University of Texas at Austin. What worries him more than the level of debt is interest rates; "too high means less borrowing and less ability to buy," he points out.
But the fact is that all developed or "rich" countries have some debt, "even Switzerland, that paragon of thriftiness," Hamermesh said.
2. Debt Establishes Your Credit History
One financial fact of life is that to prove credit worthiness, you have to borrow money and pay it back. "The trick is to do it wisely," explains James Poe, chairman and founder of Texas Retirement Specialists, a Fort Worth-based financial planning firm. "The key," he said, "is to manage your income.", which is the sum of your total debt-reduction payments divided by your after-tax
For instance, if you take home $3,000 a month, and each month, you write $1,000 in checks to your creditors, your debt ratio is 33%. "The lower the figure, the better," Poe points out. "The higher the number, the less credit you will be granted." Indeed, a debt ratio of 50% or higher raises a red flag to prospective creditors.
3. Paying Back Debts Can Improve Your Credit Score and Make Future Loans Cheaper
Paying back your loans can help you maximize your credit score once you establish it. Consumers sometimes don't have a choice of what kind of debt they take on. If they have a good credit rating, they get favorable terms, including low interest rates.
Those who don't have good credit are left with high interest rates. One playing-field leveler: The ability to pay off debt. "Make sure you make every monthly payment, avoid interest rates and late fees, and voila, watch your credit score rise," Poe said.
Taking on a little debt toward something you need now can help you seize opportunities that would not normally be available to you now. Just remember: No matter how good the rates are, you should never take on more debt than you can afford. That's simply asking for trouble.
[Want an inexpensive loan that won't risk your home or car? Check out 4 Situations When a Personal Loan is a Good Idea.]