You may have come across the terms “good debt” or “bad debt.” Debt always sounds like a negative, but when it’s leveraged to purchase appreciating assets, it can be a good thing. But there is one type of debt that is always considered bad — credit card debt. Here’s why carrying debt on plastic from one month to the next is a bad idea.
1. It comes with double-digit interest rates.
Credit card is typically the most expensive debt you can take on, with APRs in the teens and 20s — while education, mortgage and personal loans generally charge interest in the mid-single digits. This is why the Nerds don’t recommend putting large expenses like medical debt on credit cards — there are much cheaper options available.
2. The minimum payments will take you years to pay off the balance in full.
If you want a good laugh — or scare — check out the minimum payment warning on your credit card statement. It states the number of years and months that it will take for you to pay off your credit card debt making only the minimum payment. Let’s say you have a balance of $8,000 on a credit card with 18% interest and a minimum payment of $160. If you only make the minimum monthly payment, you won’t pay off the credit card for seven years and seven months and you’ll pay $6,432 in interest.
If you choose to double your minimum payment and pay $320 a month, your debt will be wiped out in two years and seven months, and you’ll only accrue $1,912 in interest. By simply doubling your payment, you’ll save five years and $4,520 in interest payments. If you have credit card debt, always pay much more than the minimum to save time and money.
» MORE: How to pay off debt
3. It isn’t used to purchase appreciating assets.
“Good” debt is typically defined as mortgage, education or business debt because, ideally, each of these investments will generate returns for years to come.
Mortgage or real estate debt is generally most profitable for those who own rental properties, but there’s also a possibility of making money from your personal residence when you sell it. Education debt is supposed to help you get a job with a better salary than you would get with a high school diploma. And business debt can be a great investment if the business succeeds. Of course, every investment requires taking some risk, but calculated risk can result in large rewards.
Credit card debt isn’t used to buy appreciating assets. It may be used for depreciating purchases — like home furnishings, clothing items or gadgets — or consumables, such as food and gasoline. There’s nothing wrong with any of these purchases, but paying interest on them is unnecessary and can raise their true prices significantly.
A good rule of thumb is to avoid going into debt purchasing things that won’t go up in value. Should you cut up all your credit cards? No, just don’t spend more on them than you can afford to pay in full each month before any interest accrues. Credit cards are a great tool when used correctly, but credit card debt is cripplingly expensive — so don’t carry it over from one month to the next.
Bottom line: Credit card debt is bad debt because of its high interest rates and low minimum payments, and the fact that it isn’t used to buy appreciating assets. Use your credit cards for the rewards and other benefits, but pay the balance in full each month.
Confused man asking why image via Shutterstock