3 types of debt you don't want
Alexander MacLennan, The Motley Fool 9 a.m. EDT August 30, 2014
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Debt is a problem for many Americans, but some types of debt are much more harmful than others. Knowing which types of debt are most harmful to your finances is important when it comes to controlling interest expenses and keeping debt under control.
When it comes to interest rates, payday loans are about as bad as they get. Annualized rates can easily move into the triple-digit range, sometimes moving as high as 500%. On top of that, payday loans come with extra fees that increase costs for borrowers even more.
If these loans are used for the short term, they still cost more than other lending options, but the cost is not as much as if they were used for an extended period of time. However, for many individuals, this is not the case. According to the Center for Responsible Lending, "The average payday borrower has nine transactions per year." Moreover, "Loans to non-repeat borrowers account for just 2% of the payday loan volume."
Although payday loans can seem like the easy solution to covering expenses, there are many better alternatives. Many community banks and credit unions offer short-term loans to cover expenses and do so at rates far better than payday lenders. Some borrowers may also want to consider borrowing from friends and family if it's only for a short period of time. Even though it may be a hassle, few friends of family members will charge triple-digit interest rates.
Credit card debt
There are situations where credit cards are a financially beneficial tool, but credit card debt is among the worst things to carry over time. With many credit cards nearing a 30% interest rate on carried balances and most others carrying at least double-digit interest rates, these debts grow quickly if not paid off.
Consider also that getting rid of credit card debt is a good financial investment. By paying down this debt, you would effectively be earning up to 30% per year on the debt paid down. Even famed investor Warren Buffett is proud of earning an average of 20% per year from his investments.
Credit card debt can arise from a number of scenarios, but too often it comes from irresponsible spending and a pay-it-off-later attitude. While not as expensive on an annualized interest-rate basis as payday loans, credit card debts pile up fast and can lead to much greater expenses down the road.
Few people like to pay the taxman, but not doing so can land you in another heap of financial trouble. As it turns out, the IRS wants what it's owed and is ready to act accordingly.
Through a sea of penalties and interest, those who don't pay their taxes on time and in full can see their debt to the IRS skyrocket. In fact, the IRS even admits that in certain cases, "The interest rate on a credit card may be lower than the combination of interest and penalties imposed by the Internal Revenue Code."
It's also important that you file your tax returns even if you can't pay in full. Not only can refusing to file a tax return potentially increase penalties but, in some cases, it can also make obtaining loans more difficult. The IRS also notes that it may create a substitute return itself for those who haven't filed. But before you think this means less work for you in preparing your taxes, when the IRS writes up the return, making sure you get all your exemptions and deductions is not exactly top priority.
Refusing to cooperate can also lead to the beginning of the collection process, including levies on wages and notice of a tax lien.
To avoid this issue, you may want to consider setting aside money, especially if your employer isn't withholding enough. And if you already know you can't pay your taxes, still make sure to file your return and get in contact with the IRS.
As many Americans struggle with debt, it's important to know which debts are the most harmful. With all their fees, penalties, and high interest rates, payday loans, credit card debts, and overdue taxes are three types of debt to avoid whenever possible.
But for the times when there is a cash shortfall, be sure to consider alternatives. Contact a local bank or credit union or even friends and family. And most importantly, don't just push the debt off until tomorrow unless you want to pay even more.
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