Whether you are just starting out or nearing retirement, debt management is an important skill to master. As a young family, you may suddenly have more expenses than ever before. By understanding the difference between smart debt and dumb debt, you can use responsible debt management to help with your changing financial needs.
Smart debtSometimes going into debt is necessary; sometimes it may even be beneficial. A smart debt typically leaves you with an asset that was worth the cost of the loan. For example, a mortgage or student loan is generally considered to be smart debt. As a part of responsible debt management, you need to understand the total cost of a loan (the principal, interest and fees) as well as whether the loan will help you or hurt you in the long run.
Dumb debtDumb debt is the easiest type of debt to fall into, and it usually results from neglecting to stick with a budget. Dumb debt often occurs when you buy things on credit that you cannot really afford. Sometimes dumb debt results from taking too long to pay off a debt and paying an exorbitant amount of interest (sometimes considerably more than the original cost of your purchase). Another sign of dumb debt is when you are paying for something after you no longer use it or don’t have it anymore. Dumb debt results in stress, a limited budget and having to sacrifice long-term financial goals. All of these problems can be avoided by practicing responsible debt management.
ChildrenChildren are priceless. Unfortunately, the expenses that go hand–in-hand with them are not. They can be quite expensive, in fact. Not only is there the cost of baby equipment, diapers, daycare, etc., but there is also the looming cost of college. This expense definitely requires careful debt management. Be careful planning now, and acquire only smart debt so you can keep your debt under control. Avoid using credit cards for daily purchases. Stay within your means -- your baby doesn’t care if she has the most stylish high chair; she’ll spit up on a hand-me-down just the same -- and you can avoid dumb debt. Also, start saving for college now. Even if preschool is years away, you should look at the estimates of what college will cost when your child will be ready to enroll. This will quickly show why it’s a good idea to start saving as soon as possible. Use a college savings account that can help your money build quickly. This is a key step in wise debt management.
HomeNow that you have children, you may feel that your current home is too small. However, if you cannot afford a bigger home yet, good debt management principles say to wait. Plan carefully and decide where you would like to live when your kids go to school. It can be worth being a bit cramped now in order to afford to move into a neighborhood with better schools later. You do not want to lose sight of your debt-management goals by taking on a mortgage that you really cannot afford. Build enough equity in your current home to help you move to a house that fits your family better.
CarThis is a tough one. A car that served you well as a young couple just may not work with car seats in the back. Children’s infant seats, strollers and toys take up a lot of room in a car. That does not mean, however, that you have to go out and buy the biggest SUV or the top-of-the-line minivan. Instead, keep good debt management in mind and comparison shop. You can find a car that will meet your needs without putting a financial burden on you.
DebtWith babies and diapers and bottles, it can be easy to neglect to pay off your existing debt. You may still have student loans, car loans or credit card debt. Through proper debt management, you can pay this off and still focus on your other financial needs. Pay off your loans with the highest interest first. There’s no need to add to dumb debt by waiting to pay off a loan that has a high interest rate. Also consider consolidating your debt with a home equity loan. Be sure to consider this option carefully, however, if you are thinking of moving. A home equity loan uses the current equity in your house, so it will not be available to you when you do finally sell your home. Also, if you consolidate your debt, don’t forget to implement good debt management in the future, so you can avoid acquiring new debt.