Understanding credit and debt

With historically low interest rates and a large number of lenders competing in the marketplace, now it’s easier than ever to borrow money. The process of applying and qualifying for credit is also fairer and more accessible than it was in the past.

This is a good thing, because it makes it financially possible for more people to pay for a home, a car or a college education. But it also means that for some there’s a temptation to borrow more than they can afford.

That’s why it’s important to become a smart borrower -- and the first step is to learn the difference between good and bad debt:

  • Good debt is borrowing to purchase an asset that is likely to go up in value. It comes with a favorable interest rate and may even be tax-deductible. A mortgage that you can comfortably afford is a good example. Borrowing to buy a business, or to upgrade your education or job skills can also be good debt, since you’re using the money to build future wealth.
  • Bad debt, on the other hand, is expensive and used to buy things that quickly lose their value. If you buy a big-screen TV and take six months to pay it off on your credit card at 18 percent interest, that’s bad debt. So is taking out a seven-year-loan to pay for a car you’ll only drive for five years.

Sometimes a debt is bad not because of what you buy, but because of the type of financing you choose. For example, if you take out an interest-only mortgage to buy a house you would otherwise be unable to afford, you could find yourself in a budget crunch when the interest-only period ends and you have to start making higher payments.

Becoming a smart borrower means using good debt to build wealth and avoiding bad debt that erodes it. Here’s how to start:

Keep on top of your credit score. Whenever you borrow money or apply for credit, the lender checks your credit score. This number reflects your past history of borrowing. The higher the number, the lower risk you are to the lender and the better interest rate you’ll receive. By paying your bills on time and maintaining a good credit score, you’ll be able to get loans at the best rate going.

Request your free credit report and score from LendingTree.

Make sure you’re getting the best rate. Check if you can refinance your mortgage to one with a lower rate, or one that pays down your principal faster. You might even be able to get your credit card company to lower the rate it charges you by simply asking. With so many lenders competing in the market, you can easily shop around for a better interest rate if you request a loan through LendingTree.

Review your credit accounts and consolidate. Paying off your high-interest credit cards with a low interest debt consolidation loan or home equity loan or line of credit may save you a considerable amount in interest rate charges. Just remember, it’s crucial that you avoid running up your credit card balances again. Otherwise you’ll find yourself in an endless cycle of debt.

 

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