When used responsibly, debt may be a powerful tool, helping people to finance a college education, automobile, or home. In these instances, debt may be used to help a person gain the knowledge needed to increase earning power, travel for work, or create a home. Conversely, if used irresponsibly, debt may be used to finance an unsustainable lifestyle which may harm individuals and families. Two types of debt people often use are revolving credit lines and installment loans.
A revolving credit line is a predetermined line of credit from which you may borrow and pay back. An example of a revolving credit line is a credit card. Used responsibly, the borrower uses no more than 30% of the revolving credit line and pays the credit card bill in full every month so the revolving credit line is restored monthly. An installment loan is created when a lender issues a loan to a borrower for a lump sum of money at a specific interest rate and the borrower makes payments to the lender over a specific period or term. Installment loans are often used to finance large purchases like a college education, automobile, or home. Used responsibly, the borrower makes monthly payments on time to the lender and the large purchase is paid in full at the end of the term.
In each of these cases, responsible debt use is highlighted. Positive consequences of responsible debt use may include higher credit scores and lower interest rates. Irresponsible debt use may be marked by cases when the revolving credit line is not paid in full or on time every month, or installment loan payments are missed, or the revolving credit line is maxed out. Negative consequences of irresponsible debt use may include low credit scores, high interest rates, and declined credit applications.
Behaviors and attitudes about money may drive debt usage. When missed payments and excessive spending become chronic behaviors, additional help may be needed. In those cases, it is important to connect with a credit counseling service for support with gaining the knowledge and skills to change behaviors.
Wendolyn Forbes is a CERTIFIED FINANCIAL PLANNER™ with Wealth Transition Finance, A Member of Advisory Services Network, LLC. Wendolyn is a fee-only financial planner and member of the National Association of Personal Financial Advisors (NAPFA).
CFP Board owns the marks CFP®, CERTIFIED FINANCIAL PLANNER™, and CFP® (with plaque design) in the U.S.
This material is provided as a courtesy and for educational purposes only. Advisory Services Network, LLC does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state laws are complex and constantly changing. Consult your own legal or tax professional for information concerning your individual situation.
Originally published in the August 2023 issue of Positively Haywood by Vicinitus.