There are three types of debt:
- There is debt that has value, such as a mortgage or car loan.
- There is debt that has little value, but it is not hurting you, such as short term credit card purchases.
- There is debt that is actively hurting your financial position, such as long term high valued credit card purchases of expendable items.
To improve your financial position you need to learn how to identify what type of debt you have and then figure out ways to dump deadweight debt.
Not all debt is bad. Low mortgage rates makes financing home purchases a smart deal. This is because housing is a cost you will have regardless if you rent or own, and with low interest rates, your home investment is likely to produce gains that outweigh your interest payments. This type of debt is fine to accumulate, as long as you stay within your means.
Another type of debt is inconsequential debt. This is a short-term debt that you can reasonable pay off within a month or two. For example, if you charge your groceries and gas to a credit card for convenience and pay off this balance within the four week grace period, then this is inconsequential debt.
Another example is using credit options to pay for medical procedures or emergency car repairs. This type of debt is necessary, and it is not going to cause long term problems if it is responsible managed.
Deadweight debt is any debt that has no value. This debt can be used to describe purchases that are charged on a credit card and not paid off for months or years. These purchases produce deadweight debt because the value of the items purchased is zeroed out before the product is paid for.
Dumping Deadweight Debt
Dumping deadweight debt is not as difficult as it first seems. Start by identifying what your deadweight debt is. Take out three separate pieces of paper. Label each page. List each debt on a separate line along with the interest you are paying for each.
Pay off the debt with the highest interest rate and the minimum monthly payment on the others. Then take the amount you were paying on the paid off debt, add it to the next minimum payment debt that you were paying with the highest interest rate until that debt is paid off. Continue this process until all debt is paid off.
While you are paying off your debt, change your charging behaviors. This will prevent you from accumulating more deadweight debt. Now create a strategy for paying off this debt.
For example, pay more than the minimum amount each month, take on overtime at work and apply this extra income to paying down your deadweight debt and/or sell non-essential items to pay off this debt.
Controlling everything about personal finances takes effort, innovation and a little thought. Put in the effort and you will reap the benefits of a stronger financial position.