5 Ways You Accrue Debt Not understanding It

Debt, based on Oxford dictionary, is “a amount of cash that a person owes”. To a lot of people, this means having the added stress of having to settle our debt after the month. For example, when we borrow money to purchase a house or car, we know we have to make repayments for the loans that people took.

These kinds of debts are obvious – and that we should think about our capability to afford each type of loans before we take them. However, there's also debts which are less obvious, and which some of us may unwittingly undertake without even realising it.

#1 Paying By Instalments

Paying by instalment is really a payment method that has its own place. It will help you manage cash flow and enables you to buy big-ticket items on a tight budget. While paying by instalments may offer a great way to own that new iPhone 12 or a luxury bag, they are able to accumulate. Toss in some furniture and electronics and you will get a much bigger bill at the end of the month when instalments are accumulated.

This is debt that can quickly and quietly snowball into a bigger amount if you do not keep track of your payments.

Stores typically partner with credit card or payments companies to provide such interest-free payment plans. They are able to range from as little as three months, to so long as Three years. Consider it, when you purchase the second plan, that means it will require you three years of resolve for paying down the product. During this time, if you miss a payment or choose early repayment, you will be hit with a slew of penalties and interest fees. As it is the bank that taken care of your purchases first, you're technically still in debt until you have repaid the full amount.

#2 Not Paying Credit Card Fees In Full

Credit cards are great because they are convenient and more secure than using large sums of cash. They provide more purchasing options (for example online shopping) and you may earn points or miles to redeem for discounts or any other rewards.

Credit card companies offer a choice to either pay the bill entirely or simply the minimum sum. Should you pay in full, there won't be any late charges or interest added. However, if you choose to pay only the minimum sum, the monthly interest kicks in. For most banks, it is a whopping 25.9% per year. Gleam late payment fee if you don't pay on time. Based on these figures, a $5,000 bill can snowball to more than $7,682 each year.

And when you choose to pay for just the minimum sum after the month, you are essentially deciding to go into debt.

#3 Recurring Subscriptions That Comes With A Lock-In Period

Recurring memberships and subscriptions that include a lock-in period is visible as a type of debt. While you might pay a regular monthly subscription, you cannot just discontinue your subscription as and when you would like. Which means that the plans, that are typically billed every month, are a cost commitment, whether they are being used or otherwise.

For example, if you subscribe to a 2-year gym membership at $100 per month that you cannot cancel, you are on the hook for that bill and are necessary to pay the gym the total amount each month, regardless of whether you utilize your membership benefits or otherwise.

#4 Buying margin/leverage

Investing on margin means borrowing funds from the bank or broker to invest in stocks/forex/etc for higher returns. Using this type of leverage is a “win big, lose big” scenario, a risky strategy that may potentially magnify your gains and losses. Around the upside, you'd be able to invest more even when you do not have available cash.

On the down-side, your losses are magnified if prices decline. Since you are using borrowed money, you also need to pay the eye on the margin loan. Any borrowed amount equals to debt incurred, and margin trading can accentuate it. Worse, if the value of your investments drops past the minimum value, you may face a margin call. You'll have to top up your margin account by depositing funds or sell shares in your account.

#5 Not refinancing your housing loan

While a housing loan is often considered “good” debt – it allows you to own property and make equity – you might be paying more than you need to. This sneaky type of debts are due to the difference in interest rates. The COVID-19 pandemic has resulted in lower interest rates. Should you refinance with another bank that provides a far more competitive rate than your current loan, you can achieve savings over the long term and lower your financial troubles. By not refinancing, you are also incurring higher debt than you need to.

For example, the total interest payable for any $500,000 loan at 1.5% interest over Twenty five years is $187,500. Switching to another loan with a lower rate at 1.3% would incur $162,500, a savings of $25,000. Check, however, if you're still within the lock-in period as there would be a penalty fee. There are also additional conveyancing and valuation fees. Still, it's worthwhile to complete the sums and you can come away with significant savings in the long run.