Should You Be Debt Free?
Like many financial matters, the decision to be debt-free is as much about how you feel about debt as it does about what makes financial sense. Before making your decision to pay off debt it’s important to understand the difference between good debt and bad debt.
Good debt vs. bad debt
A helpful rule of thumb is that good debt helps you achieve a goal or build assets, like home ownership or an education. Even some revolving credit, like credit cards, can be a good thing because a record of responsible debt management helps build your credit history.
By contrast, bad debt is debt you acquire for items you don’t necessarily need – and that don’t help you build wealth. Bad debt enables you to live beyond your means, like maxed out credit cards.
Replacing bad debt with better debt
Unfortunately, you can’t just just call up the bank and say, “Please erase my debt.” You have to pay what you owe, but often you can do it more cheaply by consolidating your debt into one loan with a lower interest rate and a single payment. Your debt may be of the “bad” variety, but consolidating it may lower your interest rate and simplify the process of paying it down. Once this debt is paid off, you can focus on the “good” kind.
A numbers game
When deciding whether or not to pay off a particular debt, you want to weigh the cost of the debt against what you’d earn if you put that pay-off money elsewhere. For instance, let’s say you have a car loan with an interest rate of 2.5 percent and you have $5000 left on the loan. You could pay off the car loan now and save $125; or you could put that $5000 in a high-yield savings account at 5 percent and earn $250 over one year.
Other factors for living debt-free
If you are approaching retirement or anticipating any phase in your life where your income will be fixed or unpredictable, you may want to consider paying off your debts to ensure that you have enough cash for living expenses. Likewise, if the idea of any debt at all keeps you up at night, you might consider paying them off for peace of mind and a good night’s sleep.
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