Escape the debt trap

Debt by itself is neither good nor bad. It depends on how you use it. A pile of consumer debt can make your life miserable, and the temporary satisfaction you derived from spending the money a long-forgotten memory. Debts are like a double-edged sword – they can be your best friend or your worst enemy depending on how you wield them. There are essentially two types of debt – good debts and bad debts.

Good debts

Good debts are debts you incur to acquire assets. This means that the item will pay for itself. In essence, you borrow and someone else pays for it. For example, if you borrow to buy a ‘keke’ or an automobile for car hire, and the monthly income from the car is more than enough to pay off the debt, you have good debt in your hands. This type of debt puts money in your pocket. It makes you rich. You want more of such debts. The more such debts you have, the richer you become.

Bad debts

Bad debts on the other hand are debts you incur to acquire liabilities. Payment on these debts comes directly from your pocket. This type of debt leaves you with less money in your pocket. It leaves you poorer although you may look affluent on the outside. You may be dying on the inside while the Jones-es wannabes are green with envy. Someone said ‘the Jones-es are broke’. This is the type of debt whereby you are hounded from pillar to post by creditors and re-possessors and you become afraid when the phone rings. This type of debt can make your life miserable if you are in over your head.

Paying off your debts

Bad debts are the type of debts you need to get out of as fast as possible. Falling behind in payment affects your credit score and makes future borrowing more expensive. Most experts advise you to tackle the highest-interest loans first – typically credit card loans, store cards, etc. This makes sense in that the highest-interest loans grow the fastest the longer you take to clear the balance.

Another approach is to tackle the smallest loan first, then the next one after that until you get to the giant one or elephant in the room. The rationale is psychological and is backed by studies. The idea is to give you momentum and keep you motivated to go the whole way, as money freed up from paying other debts is applied to bigger debts to pay them off faster.

The smallest debt is the easiest to pay. That gives you a sense of progress. The money freed up by paying that debt is added and applied to the next bigger one. This one goes pretty fast too, and you keep repeating the process. Studies have shown that this method is faster and more effective.

Oftentimes, you may have an unwieldy number of creditors to deal with, and it becomes cost-effective to obtain a consolidated loan to pay off all your loans, work outs cheaper and offers you more breathing space. You have to proceed with caution and do your sums well to ensure this is a more cost-effective option before you go this route.

Coming clean with your creditors

If you are in over your head in debt, rather than play hide and seek with your creditors, you are better off coming clean. Approach your creditors and let them know the situation you are in. Request for rescheduling of your debts and negotiate more lenient terms so that you get breathing space.

While creditors need their money as and when due, they prefer to deal with a borrower who is honest and committed to paying up than one who plays hide and seek. No creditor wants his debt to go bad, hence most are ready to be flexible.

Go and sin no more

Being debt free does not mean living a debt or credit card-free life. Using a credit card often gives you a level of protection not matched by debit cards. You can continue to use your credit card for items you have enough cash to cover. This means you clear your bill the moment you get it, essentially using interest-free credit, at the same time building your credit score towards good debts that give you the leverage of other people’s money.