Debt is an essential part of credit health. Without it, the credit bureaus cannot grade your money management skills or level of responsibility. While you may think every positive account should benefit your credit score, there are other factors to consider:
- How does this purchase affect my savings?
- Am I wasting money by choosing this method of financing?
- Is there a better way to buy what I need?
Ask yourself these questions as you review the following revolving and installment debts. What you learn could help you avoid unnecessary pitfalls.
- Financing for electronics. Let’s be honest: electronics are luxury items. Televisions, computers, phones and gaming systems may provide entertainment, but they aren’t essential household goods. So, why do so many people choose to finance them? The simple answer is affordability. When the latest smartphone or flat-screen TV isn’t part of the budget, an offer of zero-percent financing seems like the perfect solution. That said, be sure to read the fine print before signing on for this “deal.” Most zero-percent interest offers expire within 6-12 months, leaving you to pay a high premium on unaffordable items. When in doubt, stick with savings to buy the things you want. Your credit utilization ratio will thank you.
- Department store cards. We’ve all been tempted to save 15 percent at the checkout counter. Opening a department store credit card may have a few perks, but they’re rarely worth the trouble. Drawbacks to this type of debt include:
- An inquiry on your credit report, which will temporarily lower your credit score
- The temptation to overspend
- High interest rates and late payment penalties
Unless you shop at the store regularly (i.e., once a week), take a pass on this credit option in favor of cash or a card that offers real benefits, e.g., frequent flyer miles, cash back or additional savings.
- Rent-to-own purchases. Just as we learned to avoid electronics financing, rent-to-own purchases are saddled with the same risks. The average RTO retailer stocks furniture, appliances and other household essentials. If you can’t afford the sticker price, a low weekly payment may seem like the perfect deal. Think again. For example, an Ashley sofa at Rent-a-Center retails for $665 at other furniture stores. If you choose the rent-to-own option, 78 weekly payments of $24.99 a month will drive up the price to $1949.22. Why waste your emergency fund? Instead, consider saving $25 per week until you have enough to purchase the sofa at a fair price. The result will pad your bank account and help you avoid credit damage.
- Overpriced auto loans. When it comes to transportation, the cost is variable. Sure, you could lease a BMW 5 Series for $519 per month, or you could choose a Toyota Prius for $249 per month. Saving as little as $5 per day could yield more than $633,000 over time. Prioritize savings by choosing affordable options.
- Student loans. We’ve covered my experience with student loans and the long-term consequences of over-borrowing. Although the average price of tuition ranges from $9,139 to $31,231 per year, there are still ways to temper the cost. Click here to learn a few strategies.
The bottom line: Debt is a valuable tool, but not all deals are created equal. Think carefully before adding an account to your credit history. Don’t trade stability for convenience.