Is It Good Debt or Bad Debt?

by Spencer Tierney 29. October 2014

Empty Wallet

Most people borrow money at some point in their lives, but many may not realize that having the right kind of debt – and paying it off as promised – can show money management smarts rather than poor spending habits. Here’s how to sort the good from the bad when it comes to owing money.

What is good debt?

Think of good debt as an essential element to making substantial purchases you can’t otherwise afford now but should help you produce value later, such as paying for college or a major business expense. In the long term, this borrowing is worthwhile because of its anticipated future benefits. Here are some more examples:

Mortgages
A mortgage is a necessary debt for most people who want to own their own home. It’s considered smart debt because a house will likely appreciate in value at a faster rate than the interest on the loan. Additionally, the interest paid on a mortgage is usually deductible from income for federal tax purposes, which effectively reduces the cost.

Borrowing for Business
Financing a business with a commercial loan is smart because it probably will generate increased value for the operation. The money needs to be used to improve products and services offered, or in other ways that will grow the company.

Student Loans
Paying for an education is one of the best ways to invest in yourself. Taking out loans is considered good debt on the assumption it will produce a lifetime of benefits by equipping you to qualify for better jobs that result in higher income. But make sure to not borrow too much.

What is bad debt?

Bad debt, on the other hand, doesn’t increase your wealth over time and often comes with a high interest rate. It’s the type of borrowing frequently used to pay for things you don’t really need. Some examples of bad debt are:

High-Interest Credit Cards
Credit card balances and the resulting interest are considered bad debt because there’s no anticipated gain. In fact, if balances mount too high or interest rates rise, it can quickly turn into a vortex of financial difficulties.

Payday Loans
This form of very short-term borrowing is described as a debt trap by the U.S. Consumer Financial Protection Bureau, partly because of the high fees and the checking account access given to the lender. If you can’t pay right away, the fees can quickly become exorbitant; the average annual percentage rate for a payday loan is about 400% and can run as high as 5,000%. And most people who use them can’t pay them off on time and must refinance repeatedly, according to the government agency. It’s easy to get into a big financial pickle with payday loans, so they are best avoided.

Not every form of debt will fit neatly into “good” or “bad” categories. For example, a car loan may be smart if you get a low interest rate and can pay it off while you still own the vehicle, particularly if having the transportation means you can get a better job. It’s bad debt, though, if the amount borrowed and the interest rate are so high that payments will probably continue long after the car is gone. The key thing to consider is whether the purchase being financed will gain or lose value over the long run.

Spencer Tierney is a staff writer for NerdWallet, where he covers all aspects of personal finance.

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Bank Jargon 102

by Spencer Tierney 26. June 2014

Banking Terms

Do financial statements baffle you? Do your eyes glaze over when your banker seems to be speaking another language? Chances are you aren’t up to speed on the latest bank jargon. Once you decode these common bank terms, you’ll be in a better position to manage and grow your assets.

Available Balance

You may have noticed that deposited funds aren’t reflected immediately on an online bank statement or paper receipt. That discrepancy occurs because your available balance refers to the total account balance minus any uncollected funds or restrictions. Checks that still have to be cleared won’t show up. Additionally, if your account has any debits pending or other restrictions, your available balance will be less than the full amount deposited to the account.

Understanding an available balance is vital because it reflects the accurate amount of your usable cash. Always refer to this figure when writing checks or paying bills online to avoid overdrafts or bounced checks.

Credit Card Balance Transfer

A balance transfer allows you to move your outstanding balance from one credit card to another, usually to reduce the interest rate or enjoy a period of no interest at all. The promotional rate only applies for a fixed period and you may have to pay a balance transfer fee.

Balance transfers can help you pay off debt faster and with less expense.

Certified Check

When you make a major purchase, you may be asked to pay by certified check. A certified check is a check drawn from your account that’s guaranteed. Your bank will certify a check on your request, with a bank official’s signature. This signature guarantees that your signature is genuine, that you have sufficient funds in your account and that these funds have been earmarked to pay this check. Most banks charge a fee for a certified check. See the 1st Mariner Bank Schedule of Charges for details.

Understanding certified checks ensures that you’ll be able to make purchases that require them without unnecessary delay or complication.

Co-Signer

When a borrower has insufficient credit, he or she may need a co-signer for credit approval. A co-signer promises to pay a loan or satisfy a financial obligation if the primary account holder defaults. A co-signer’s legal responsibilities may include the full amount of the debt as well as interest, late fees and collection costs.

If you don’t have good credit, finding a co-signer may help you borrow money and establish credit. If on the other hand, someone asks you to co-sign a loan or credit card, a clear understanding of what this obligation entails is essential.

Frozen Account

If your account is frozen, this means you won’t have access to that money until the bank unlocks it. Accounts may be frozen due to liens, court orders, legal processes or dispute over account ownership.

Knowing why accounts are frozen may help you avoid this experience. If your paychecks are directly deposited to an account that gets frozen, you’ll need to stop this direct deposit immediately for continued access to your pay.

Traditional Individual Retirement Account (IRA)

Traditional IRAs are retirement savings accounts that are tax-deductible up to certain specified limits. You can’t withdraw these funds without penalty until you reach age 59½. Once you withdraw money from your IRA, it becomes taxable income.

Investing in an IRA may significantly reduce what you owe in income tax today, while helping you save for retirement.

Loan-to-Value Ratio (LTV)

LTV is the ratio of the amount you’re borrowing to the actual value of your purchase. For example, if you need to borrow $450,000 to purchase a $500,000 home, your LTV would be 90%.

The lower your LTV, the more likely you’ll be able to negotiate good interest rates and loan terms.

Payable-on-Death (POD) Account

A POD account allows you to designate a beneficiary who’ll inherit this account after your death. During your lifetime your beneficiary has no access to your account.

Converting your bank accounts to POD status assures that your assets will automatically belong to your loved ones when you pass, with no danger of a probate delay.

Power of Attorney (POA)

A POA is a legal document that authorizes one person to act for another. It may be a general authorization or a specific one defining a time period, act or event.

If a loved one becomes too ill to manage finances, he/she may grant you power of attorney to make important decisions for him/her or make payments from his/her bank accounts. Even a healthy person may use a POA, such as the case when you’d want to grant your accountant power of attorney to obtain certain financial documents on your behalf to resolve a tax dispute.

Spencer Tierney is a staff writer for NerdWallet, where he covers all aspects of personal finance.

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Bank Jargon 101

by Spencer Tierney 15. May 2014

Bank Jargon

Whether you just opened your first checking account or want to know all that’s on offer at your local branch, it’s wise to learn the language spoken by your bank. Consult the following list to upgrade your banking vocabulary.

CD

A certificate of deposit, or CD, is a savings product offered by financial institutions. It earns a higher interest rate (see below) than a regular savings account, but that comes in exchange for locking up your money for a specified period of time, from a few months to a year or more. Withdrawing money before the term is over will result in penalty fees. Be aware that there are fixed CDs and “flex CDs.”

How it is relevant to you: A CD can be a useful mechanism for long-term, recurring savings. One strategy to use when managing CDs is a CD ladder, which involves reinvesting short-term CDs into longer terms.

eStatements

An eStatement is an electronic copy of your account statement, delivered to you via email. Many consumers have switched from the traditional, mailed statements to eStatements for the sake of convenience and security.

How it is relevant to you: You can download and save your statements to view whenever you want. And they’re safe, since they won’t get lost in the mail or stolen from your trash.

Interest

Interest refers to the charge that comes with borrowing money (such as on credit cards and loans), or the profit that is made from loaning or depositing money (such as in saving accounts or CDs). There is no uniform rate across banks. However, the national average rates can give you a sense of the trend.

How it is relevant to you: It’s important to understand interest rates to see if you are taking full advantage of your savings products—or paying too much on your credit cards.

Money Market Account

A money market account is an account that generally offers a higher interest rate than a savings account but also requires a significantly higher balance to maintain. This type of account provides you with limited ability to write checks.

How it is relevant to you: Unlike with a CD, you have the opportunity to make a limited number of withdrawals from your account.

Overdraft

When you try to make a transaction that exceeds your balance—say, you try to use your debit card to buy a $200 smartphone but there’s only $100 in your account—your bank will do one of two things: (1) decline the transaction or (2) let it go through, causing you to “overdraw” on your account. In this second scenario, your account balance is now in negative territory, and your bank will charge you an overdraft fee. An overdraft can also happen when attempting to withdraw money from an ATM or writing a check.

How it is relevant to you: Keep a close eye on your account balances, because overdraft fees are expensive and can add up quickly.

Wire transfer

In much the same way as email moves a letter from one person’s computer to another’s electronically, a wire transfer moves money from one person’s account to another person’s account electronically. This can be done when people have accounts at different banks or at the same bank. Wire transfers are expensive due to typically high fees charged by banks to both parties. If the money is needed right away, consumers should know that banks send out wire transfers at certain times of day, and you could miss a cut-off time.

How it is relevant to you: Wire transfers are often used for large purchases, such as the down payment on a home.

Spencer Tierney is a staff writer for NerdWallet, where he covers all aspects of personal finance.

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