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Not All Debt Is Equal

Scales Weighing Credit card vs. HouseA smart credit shopper doesn’t need to be at the mercy of lenders. It pays to have knowledge of options and shop around to compare interest rates and repayment terms.

For example, a home loan or mortgage usually is one of the better forms of debt because most homes increase in value over time. Also, the interest paid on the loan may be tax deductible. A student loan is another type of “better” debt because educated workers generally earn higher wages (assuming that you are able to turn your degree into a lucrative job).

Consumer debts such as balances on credit cards and car loans generally do not increase in value over time, making them less favorable types of debt. The interest paid on consumer debt is likely to be high and not tax deductible. 

Before using credit to make a purchase, it’s good to know the costs and benefits of that particular type of debt. Some of these costs and benefits are outlined below.

  • Typical Costs:
    • Interest on outstanding balances
    • Late payment fees
    • Annual fees
    • Over-the-limit fees
  • Benefits:
    • Allows purchases to be made now
    • Reduces the need to have cash
    • Offers a record of purchases
    • Consolidates debt into one payment
    • Has purchase protections
  • Typical Costs:
    • ­ Interest on outstanding balances
    • Finance charges to originate the loan
    • Prepayment penalty (varies)
    • Late payment fees
  • Benefits:
    • Monthly payments can help afford a better car than a cash transaction
    • Generally a fixed interest rate
    • May be able to negotiate extras if the loan is through the car company
  • Typical Costs:
    • Loan fees (depending on your loan type)
    • Interest fees (depending on your loan type)
    • (Use this information from Federal Student Aid to get a complete picture of interest and fee charges.)
  • Benefits:
    • Lower interest rates than private loans
    • Payments can be deferred up to three years
    • Offer forgiveness, if you meet the guidelines
    • Can be consolidated without the need for good credit
    • Can be obtained without a credit history
  • Typical Costs:
    • Upfront fees to secure loan:
      • Fees to lock in rates
      • Origination fees
      • Appraisal/inspection fees
      • Title search fees
      • Escrow and recording fees
      • Prepaid interest (also known as “points”)
      • Closing costs
    • Fees on loan:
      • Interest on outstanding balance
      • Late payment fees
      • Prepayment penalty (varies)
  • Benefits:
    • Tax deductions on interest paid for the year (this also applies to home equity loans)
    • Closing cost deduction (first year of ownership)
    • Property tax deduction
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