Conquering consumer debt

Borrowing via credit cards, auto loans, and the like is an expensive way to
borrow. Banks and other lenders charge higher interest rates for consumer
debt than for debt for investments, such as real estate and business. The
reason: Consumer loans are the riskiest type of loan for a lender.
Many folks have credit card or other consumer debt, such as an auto loan,
that costs 8, 10, 12, or perhaps as much as 18-plus percent per year in interest
(some credit cards whack you with interest rates exceeding 20 percent if you
make a late payment). Reducing and eventually eliminating this debt with your
savings is like putting your money in an investment with a guaranteed tax-free
return equal to the rate that you pay on your debt.
For example, if you have outstanding credit card debt at 15 percent interest,
paying off that debt is the same as putting your money to work in an investment with a guaranteed 15 percent tax-free annual return. Because the interest on consumer debt isn’t tax-deductible, you need to earn more than 15
percent by investing your money elsewhere in order to net 15 percent after
paying taxes. Earning such high investing returns is highly unlikely, and in
order to earn those returns, you’d be forced to take great risk.
Consumer debt is hazardous to your long-term financial health (not to mention damaging to your credit score and future ability to borrow for a home or other wise investments) because it encourages you to borrow against your
future earnings. I often hear people say such things as “I can’t afford to buy
most new cars for cash — look at how expensive they are!” That’s true, new
cars are expensive, so you need to set your sights lower and buy a good used
car that you can afford. You can then invest the money that you’d otherwise
spend on your auto loan.
However, using consumer debt may make sense if you’re financing a business.
If you don’t have home equity, personal loans (through a credit card or auto
loan) may actually be your lowest-cost source of small-business financing.