In order to avoid bad debt, you have to know what debt products are bad debt in the first place. Many banks and other companies offer these exotic financial products that sound too good yet can be hazardous to you. Debt can be a double edge sword but for the most part, the debts found in the marketplace are hazardous. Here are 3 well known debt products that are hazardous:
# 1 Borrowing from your 401(k) or 403(b)
In almost all cases, you will not get a great deal at all. Your 401(k) loans are pre-tax, which means that the money that you put in will get taxed when you withdraw it. Taking out a loan from your 401(k) or 403(b) means that you will be borrowing from pre-tax dollar which will sooner or later have to be repaid. When you finally retire and start withdrawing, you will be taxed again. If you borrow money from your 401(k) or 403(b), you will in effect be taxed twice. Not smart. Did you realize that you're also expected to repay the loan in only a few months? If you do not have the money for repayment, your loan will be treated as a withdrawal. Expect a-smack-the-face 10 percent early withdrawal penalty.
#2 Variable Interest Mortgages
Don't get tricked by those low initial teaser rates for financing your new home. If you cannot afford the home with a fixed mortgage, you should probably not buy the home. Avoid option adjustable rate mortgages too. This causes your loan balance to become bigger each month as the lender adds the unpaid interest on the balance of your home loan. They may sound great at first but when the interest rate changes, hence your payment amount, you can be in for a big surprise.
#3 Store Credit Cards
"Ooooh 15% off, if I open a card!"
That is how store credit cards lure you in. Store credit cards come with APR rates as high as 30%. That means paying an additional 30% on your item... well 15% if you include the discount, nonetheless, if you don't pay the credit card balance in full, you will end up paying more for an item due to interest. For illustration purposes, let's say you buy an item for $500.00, you open the card to get the 15% off, knocking the price down to $425.00. You get the bill in the mail and only pay the minimum payment every month until it's paid off. Fast forward later, assuming the card holds a 30% interest rate, you would have paid $714.00 for an item that originally costs $500.00.
Anytime you borrow money, whether it is in a form of a loan through a 401k/403b, a mortgage to finance your home, or a store credit card, you become a debtor, a slave, to the product. Educating yourself to figure out which debt product is hazardous is important to maintain good financial standing.