Personal Loans and Smart vs. Foolish Debt
Credit cards are not the only form of credit available to consumers. There are also personal loans. Personal loans differ from credit cards in that they are not considered revolving accounts. That is, there are set number of payments, called installments, needed to pay off the loan and the loan balance does not increase like it would on a credit card account. Personal loans are generally more difficult to get approved for than credit cards. If you have a credit history that is not ideal, collateral may be required to have the loan approved. Collateral is something of value that is used to secure a loan. Collateral can be anything from an existing savings account with the lender, stocks & bonds, or a piece of property such as a house in your name. In the event that the loan goes into default, the lender may seize the collateral to offset their loss.
Another feature of a personal loan that differentiates it from a credit card is the method used to calculate interest. Simple interest is the most popular method for calculating interest on personal loans. To calculate simple interest multiply the interest rate by the length of the loan and by the amount borrowed, the principal. Personal loans are more affordable for consumers than credit cards and are a better way to borrow money.
Smart vs. Foolish debt (mortgage vs. toys)
No discussion of money would be complete without addressing the fundamental issue that plagues so many people in our compulsive spending culture which is how to go about making good choices with money. The divide between the rich and the poor is growing, but this divide cannot be explained away by a few commas in the savings account. There is more than money that separates the haves from the have-nots. More often than not, wealthy people are more knowledgeable and savvier about money than the average person. Wealthy people view money as a tool. They use it to work for them, not the other way around.
In order to adopt a wealthy person's mindset, which is geared towards financial empowerment, whenever you spend money you need to ask yourself how your spending will affect your overall financial health. Will it help you accomplish your short and long-term financial goals? Consumers need to treat their personal finance like a business and be more dispassionate about making purchases. Impulsive "retail therapy" is not the way towards financial empowerment. Emotionally gratifying spending has to occur in the context of sound money management principles. To this end, you should avoid incurring debt whenever possible, especially debt that does not positively impact your bottom line. Buying a brand new $40,000 luxury automobile, for example, is a frivolous purchase if you are not already a homeowner. A car depreciates the moment you take it off the car lot, so you lose money immediately. Borrowing money to buy a luxury car is an example of bad debt. Not all debt is bad however. Instead of choosing to purchase the brand new luxury car, your money would be better spent if you were to buy a used car and putting the balance towards a down payment on a home. Buying a home is an example of good debt. Homes generally appreciate in value over time and home ownership has tax advantages. Thus, homeownership is a good way of making your money work for you.
It is important to apply this understanding of good and bad debt to all aspects of your spending, not just the large purchases. Even small purchases can whittle away at your bottom line. Eating out is a prime example of this. Many people eat out for lunch during the week. At $5 a meal on the low end, that is $100 per month spent on lunch alone. Making bad choices about small purchases is akin to putting a pin hole in your wallet and letting the money drip out. You have to decide that you want to be one of the "haves" in life and that you are going to get there in time by making wise choices.