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Neighbors FCU


Understanding Financing and Debt - Saturday, March 1, 2014
Many consumers will finance at least one purchase in their lifetime, which means debt will be a part of that process.  Knowing when to carry "good debt” and when to avoid "bad debt” is an important step to building wealth and securing fiscal stability.  Learn about financing and debt here!

What is financing?
It’s the act of obtaining funds to buy an item which is then repaid, along with a fee or interest charge, over a set period of time.  Financing is often obtained for larger purchases, which cost more than the consumer may have on hand, such as for a home or vehicle; the amount financed is debt.

How does it work?
Financing can be obtained directly through the seller of the item, such as dealership financing, or through a third party when your financial institution finances a vehicle, house, or even a credit card.  The amount of the unpaid balance is considered debt.  Depending on whether the item will improve your assets or lose its value will determine if it is "good” or "bad” debt.

What is "good debt”?
Good debt is considered an investment which creates value or will increase in value over time.  Common examples of this include a home mortgage, land purchase, most college degrees and used vehicle purchases.

What is "bad” debt?
Author David Bach sums up bad debt as such: "When you buy something that goes down in value immediately, that's bad debt.  If it has no potential to increase in value, that's bad debt”.  Using your college student loan to buy pizza or go on spring break is a classic example of bad debt.

Are there any benefits to financing or carrying debt?
Financing allows consumers to make purchases which can build their assets and improve their financial situation.  A great example is buying a home with a fixed interest rate; the property is purchased at today’s value and the owner pays a set amount for the term of the loan (30 years).  At the end of the loan the owner can sell it.  The same person who rents that property would face rental increases over that same 30 year time period while gaining no ownership or value in the property. 

What you need to know:
Pay upfront for purchases which lose value quickly, like meals out, so that the items you finance will work to improve your net worth and financial stability.  Come to one of our workshops to learn more and get the answers to your questions.