Most people will agree that debt is a bad thing. I'm not talking about a reasonable mortgage on your home or a five-year car loan at a low interest rate. Debt on credit cards that you cannot pay off each month or a six- or seven-year car loan on a car you won't keep until the end of the loan term is bad debt. Even a home mortgage that is a struggle to pay each month is the bad debt I'm referring to.
Here are five of the reasons why debt is your enemy:
1. Everything You Buy Costs More
When you owe money on a credit card, every purchase you make takes away from funds that could be used to reduce your debt. Since you are paying interest on your debt, you are effectively paying interest on every new purchase, even if you don't use your credit card to buy the new items. In other words, if you didn't buy something new, your cash could be used to reduce your debt which would reduce your interest payments.
2. You Reduce Retirement Savings Rate
Carrying debt means you are paying interest on what you owe instead of receiving interest on your savings. Missing out on your savings paying you means you are missing out on compound interest working in your favor. In addition, all debt payments are funds that are allocated to paying for something you bought in the past, not funding your future retirement.
3. Your Standard of Living in Retirement Will Not Come Close to What You Are Accustomed to
If you are living beyond your means before retirement, you cannot expect to be able to live the same lifestyle when retired on a reduced income. And that's if you can figure out how to retire at all while paying off debt. (For related reading, see: How the Cost of Debt Affects Retirement.)
4. Managing a Surprise Economic Event Can Quickly Become Untenable
If you carry debt rather than keeping a fully funded emergency account, you are not in a position to handle surprise expenses. Homeowners and car owners quickly learn that things break, and the older the house or car the less likely a warranty will cover it. While not everyone gets sick and has to spend time in a hospital, a short hospital visit can be very expensive, even with insurance. Deductibles and co-insurance can add up quickly and push credit cards to their limits for those who are already in debt.
5. Debt Causes Stress
Carrying credit card debt and knowing you still owe someone else money for your possessions is a major cause of stress in many households. Those who fund vacations with credit card debt find the experiences much less relaxing. Even for people who have a plan to pay off the debt within a year or two, the concern over what would happen if they lost their job can fester into health and/or marriage issues. (For related reading, see: Your Financial Life: From Stressful to Stress-Free.)
Getting out of debt is not easy. It takes a change in lifestyle for most people who cannot figure out how to make more money in their careers. The important step is to start making a change in spending habits. Even small changes can have dramatic effects.
(For more from this author, see: How Understanding Risk Is Key to Investing.)