Bank finance articles and tips

Mastering debt management is a necessary aspect of making your money work for you. A good place to start on your road to Financial Freedom is learning debt management and to begin you have to know the difference between good debt and bad debt. First let me give you some definitions:

Good Debt: Any debt where the cost of the debt will be surpassed by the profits that are made by whatever it is that you took on the debt to buy is good debt.

Bad Debt: Any debt where the cost of the debt will amount to more than the profits that will be made by whatever it is that you took on the debt to buy is bad debt.

It's that simple. When you are looking into taking on debt do not just be mesmerized by whatever it is that caught your eye. Debt management mandates that you have to run the numbers. Yes, you can finance that car and drive it off of the lot right now, but is it worth it to pay $40,000 for a $19,000 car? Even if you have to use your last $5,000 as a down payment? If your answer is yes then there is no help for you. You are incapable of debt management. Stop reading now. For those of you with the common sense to say "No" to the above question I am going to give you a jewel that was given to me by some of the best to ever do it. This jewel was dropped on me when I was sixteen years old. I was told that debt management is essential to accumulating wealth and that anybody who knows anything about debt management would never even consider putting $10,000 down on a $100,000 dollar car.

That would be counterproductive. A true hustler would use a $10,000 dollar car to make $100,000. That is debt management. I was told that the key to debt management is not to avoid debt entirely. The key to debt management is learning how to use debt to your advantage. I have never forgotten this piece of wisdom and it is a jewel that can be applied to every aspect of our financial decision making process. The difference between good debt and bad debt is that good debt is going to pay for itself and put more money in your pocket while bad debt is money owed for an unnecessary item that you couldn't pay for. Control yourselves people. Now it is time for another definition:

Necessary Debt: Any debt that is essential to either the running of your business or to taking care of your business is necessary debt.

Examples of necessary debt include things like a car, a house, credit cards, student loans, and any other recurring business related expenses that you may have. The important thing to understand about necessary debt is that it can either be good debt or bad debt depending on the circumstances. This is important. Due to the fact that I know that most financial advisors put the items that I listed in either the good debt or bad debt categories, I am going to explain why I call the above expenditures necessary debt.

The Mortgage: The American Dream has turned into the American Nightmare. Unless you have been living under a rock you know that this once all-american investment is now under heavy scrutiny. People have been led to believe that their house is the most expensive purchase that they will ever make in their life. This is not always true. In some instances it will be your mortgage loan that is the most expensive purchase that you will ever make in your life. It is not uncommon to see the cost of getting the loan (the interest) amount to more than the principle of the loan itself. You end up paying the bank $160,000 to loan you $150,000. So if you hold onto the house for the life of the loan you end up paying $310,000 for a $150,000 dollar house. I know what you are thinking, that the value of the house will appreciate over time thereby offsetting the interest charges on the loan.

That is what you were thinking right? Right? Well that would depend on the property that you are getting, but judging by the millions of Americans who either lost their homes to foreclosure or are underwater on their mortgages I think its safe to say that the appreciation of a property can not make up for a bad deal. If you can get a good deal on the house in that you get it at a price where your money is made when you buy, the mortgage that you take out on that house can be considered good debt. When I say that your money is made when you buy what I am saying is that you get the property at such a low price that even if the value doesn't appreciate you would still turn a profit if you were to sell. This is the only time that a mortgage can be considered good debt. If you want a house just because you are still holding on to a dream that America woke up from many moons ago then that is your decision to make. Just understand that if you do not get the type of deal that I described above then you are taking on a bad debt. This is considered a necessary debt because you have to spend some type of money on a roof over your head, however you can always lease or rent until you can find a deal that is worth locking yourself into for the next 30 years.

The car loan: This is definitely a problem area. The car loan is the most abused debt there is. This is very simple. If you do not have Benz money do not go out and get a co-signer to help you get into a car that you cannot afford. Do not go to the shady dealership around the corner where you know that if you go in there will $5000 that they will get you into whatever car you want regardless of income. The end result is usually repossession in which case you will be coming back to this website to read up on restoring your Credit. Another common result of this is that since you only had a small percentage of the asking price to put down at the time of the purchase that you are now stuck with a large car note. When you add this with the full coverage car insurance that you have to pay every month (full coverage is mandatory on a financed vehicle) and whatever other bills that you have to pay for you are usually left with no money and you officially become that person in the 7 series who rarely takes it out of the garage because you have no gas money. Trust me that is not a good look. The car loan is a necessary debt because you have to get from point a to point b.

That is a given, but it does not mean that you have to spend all of your money to do it. I' m talking to the people that go out and buy $60,000 dollar cars because they wanted something "reliable". That is the reason that most people give for why they went out and spent too much money on a car. In case you didn't know Mercedez is not the only manufacturer that makes quality cars. Sorry to burst your bubble. Just because you need a car does not mean that you have to spend foolishly on one. My formula to determine whether or not your car loan can be considered good debt is simple. I call it the 5% rule. Your monthly car payment should not be more than 5% of your monthly income. For example if you make $50,000 a year, which comes out to approx. $4166 a month, then your car payment should be no more than $208.33 a month. If your car payment is 5% or less than your income then you have made a savvy investment and that car loan is a good debt. If your car payment is any more than that then you went above your means and you have taken on bad debt.

Credit cards: Out of the three examples I am giving you this is the easiest for me to explain and it should be the easiest for you to understand. The only time you should use a credit card is when you do not have the money to buy whatever it is that you need. I don't just mean when you don't have the money in your pocket. I am saying that if you have the money anywhere you should go get it and use it. Credit card debt is some of the most expensive debt in the universe. I don't know about you but I am in the business of making money, not giving it away. Every time you give a company $5 to spend $20 that is exactly what you are doing. The only justification for using a credit card is that the money that you are going to make off of whatever it is that you are buying is going to be enough to have made a decent profit after making back the cost of the item itself and the extortionary amount of interest that you were charged to make the purchase with the credit card.

The only exception to this rule is if you are building credit (see the credit section for details). I consider credit card debt to be a necessary debt because when you are trying to run a business or when you are trying to take care of business there are gonna be times where you will need access to more cash than you have on hand. At these times a credit card can be invaluable. If used for this purpose credit card debt is good debt. I don't think I need to tell you that a shopping spree on credit at Saks is bad. Three words: The Great Recession. If you haven't learned that too much leverage is potentially fatal by now then you may never learn. Use it wisely.

NaQuan L. Gray is a finance major at the University of Pennsylvania School of Business. His goal is to educate the people on the importance of money management and to show people how financial literacy can improve the quality of their lives. To read more of this authors articles visit his website at http://www.astonagendas.com.

By NaQuan L Gray
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