Debt doesn’t have the best reputation in America, even though the country’s household debt has hit $14.6 trillion in the spring of 2021.
The pandemic is a major factor in why so many people became indebted. But pre-COVID-19, numerous Americans are already burdened by debt, especially student loans, mortgage loans, and personal debts.
Clearly, for many people, borrowing money is the only way to buy the things they need. It helps with wants, too; credit card perks encourage consumers to keep buying, so debt isn’t now a last resort but an automatic method of paying for the stuff we acquire.
However, debt is cloaked in misconceptions. If you approach a frugal person for financial advice, they’d most likely tell you to stay away from debt.
They’d say that borrowing money only tempts you to spend what you don’t have. Debt does sometimes trigger unnecessary and excessive spending, but it has its fair share of benefits, too.
That said, here are the top misconceptions about debt that stop people from realizing its perks:
1. All debt is bad
Bad debt exists, but it’s not all debt because good debt also exists. You can actually borrow money to help increase your net worth or grow your earnings. Student loans and mortgages are in a good category, but there are no guarantees.
That means your quality education won’t automatically secure a high-paying job, and your home might depreciate over time. Even a small business loan, which is also considered good, guarantees nothing because many startups fail within the first five years.
The term “bad debt” is mostly used in business because it’s defined as the receivables that can no longer be collected. So from an individual’s perspective, bad debts are the type of loans that do little to improve your financial outcome-for instance, credit cards.
Though you can get perks from using your credit, they don’t often give you anything of value, like a house or a car.
2. Closing unused credit card accounts will help improve my credit score
Your credit score is stated in your credit report, which records all your financial activity. As such, many people think that having unused lines of credit in your credit report will resort in a lower credit score. But this is untrue because closing those accounts will, in fact, hurt your credit more.
Your credit score factors in when you opened each credit card account. Thus, older accounts boost your score, especially if you repaid them all on time.
On the contrary, closing an old credit makes you lose that age advantage, causing your credit history to appear “younger” and thereby suffer a lower score.
3. Eliminating debt will immediately improve my credit score
Paying a long-overdue debt won’t make a significant change in your credit report, at least for a time. Most negative information stays in your credit report for seven years. If you’ve been bankrupt before, your credit report will reflect that for 10 years.
While eliminating some of your debts can indeed improve your credit score, it won’t erase your bad records. Your improved financial habits will take a while before reflecting on your new credit report.
4. Buying a home with your own savings is better
People who get a home loan aren’t necessarily short on savings. They just realized that in the long run, a mortgage makes more financial sense. Sure, using your savings spares you from interest payments, but those extra fees can result in tax cuts.
You can deduct mortgage interest, points, and property tax from your annual income tax return. Qualified private mortgage insurance may also be deducted. If you use part of your home as an office, you may also deduct a portion of your homeowner’s insurance and other household expenses. In addition, you can build equity from your home.
Equity is the percentage of the home that you already own. If you bought your home for $300,000, and you already paid 50% of that to your reputable mortgage provider, then the $150,000 value of your home is now yours to profit from.
If your abode appreciates, your equity will also grow. That’s one of the benefits of a home loan you can’t easily get from using your savings.
5. A large amount of debt leads to bankruptcy
You’ll only be bankrupt if you didn’t manage your debts well. You can juggle three large debts and still stay on top of your finances. The key is organizing your financial obligations, knowing how much you owe, and paying your bills on time. Of course, watching your spending is also critical. Basically, don’t spend what you don’t have, and your debts won’t spiral you into bankruptcy.
It may be daunting to face several debts or even just a single one with a huge principal. But debts weren’t created to coerce people into restraining their spending. Instead, it gives people the chance to obtain their needs for a manageable cost.
So if you think your credit is good enough, see which loans may improve it even more.