It’s important to thoroughly review credit card and loan offers before signing on the dotted line. When you understand how credit and debt work, you can keep your finances on track.

Have you ever wanted or needed something and not had enough money to purchase it with cash? Sure. It could be as small as a pair of shoes or as big as a new car. Understanding how credit and debt work and using it wisely just might get you what you want. Here’s what you need to know.

Is All Debt Bad?

Contrary to popular belief, not all debt is bad. For instance, when you purchase a home, you’ll apply for a mortgage. Based on your creditworthiness and likelihood that you’ll repay the loan, the bank decides to make the loan or not. In most cases, you wouldn’t be able to make a large purchase like a home without a loan.

Debt, if used wisely, can also help increase your credit score. By the same token, it can also damage it significantly if used carelessly.

Photo of a man going through his financials problems

Loan Debt

A loan is a serious financial commitment that shouldn’t be agreed to without consideration. How can you prepare?

  • Know your credit score, what it means to the lender and why it’s important.
  • Be sure that you clearly understand the cost of borrowing funds. That includes educating yourself on interest rates, fees and any other charges. Any of these can raise the amount of your loan above the borrowed amount.
  • Calculate how much you can afford to borrow. There are online loan calculators that can help you figure out monthly payments. These are based on how much you’d like to borrow, average interest rates and the length of the loan. Make sure the payments fit into your budget before you get your heart set on something you want to buy.

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Credit Card Debt

On the opposite end of the spectrum is revolving debt. Although loans are considered a type of debt, the interest rates are generally reasonable. There also are specific terms that mark the end of the payments and a zero balance.

Revolving debt generally refers to credit card debt. While using credit to pay for purchases is widely accepted, it’s a top reason people gradually slip into financial trouble. If you don’t pay your card balance by month’s end, the remaining balance rolls over into the next month. Interest is charged on that amount and added to the balance. You can see how easily your balance can get out of hand, especially when credit card interest rates are high.

The start of a healthy relationship with credit begins with the basics of your accounts. When evaluating credit cards, it’s critical to:

  • Understand your card’s interest rate. Does it offer an introductory rate, a balance transfer rate and a cash advance rate? They can vary dramatically, so be sure you know what you’re paying, when and for how long.
  • Compare credit cards. They’re far from being created equal. Banks, credit unions, retailers and credit card companies all issue credit cards. There are many to choose from and each one is trying to win your business. Choose the one that offers you the best rates and features.
  • Read the agreement carefully. The contract you sign is binding. Once you sign, you form a legal contract and consent to the terms set by the issuer.

Wise borrowers try to maximize good debt and minimize bad debt. If it comes to a point where you aren’t able to make payments, then yes, all debt is bad. It’s a fine line we walk when we try to manage debt. The best approach is to educate ourselves, consider our options, monitor our spending and follow a financial plan.