You probably know one of the most basic rules of personal finance: Spend less than you earn.
Understanding how debt works is key if you want to improve your financial situation. To help you avoid debt, here are 10 debt traps you should watch out for.
1. Deferred interest credit cards
If you’re shopping around for a new credit card, you might see offers that state “no interest if paid in full within 12 months.” These are deferred interest credit cards and can leave you paying a lot in interest if you’re not careful.
With a deferred interest card, if you don’t pay off the full balance by the end of the deferment period, you’ll be stuck paying all of the interest that has accrued over the past 12 months. Yikes.
How to avoid it: Look at the fine print to see if you have a deferred interest credit card. If you do, make sure you have a payment plan that will allow you to pay off all of the interest by the end of the deferment period.
2. Using a credit card for daily transactions
Using a credit card for day-to-day transactions isn’t necessarily a debt-trap, as long as you pay your balance off monthly. But using credit cards can lead to overspending and more debt if you’re not careful. Studies show that when we pay for things with a credit card, we spend more than we would if we were to pay for them with cash.
How to avoid it: If you use credit cards for convenience, set yourself a spending limit based on your budget each month. If you can’t stick to that spending limit, it might be time to ditch the credit card.
3. Going into credit card debt for points
Credit card bonuses can be enticing. But big offers like miles, points, cash back and more come with a temptation to overspend.
How to avoid it: If you sign up for credit cards that offer a big sign up bonus when you hit spending requirements, don’t let that influence your spending. Spending more than you can afford or racking up interest charges isn’t worth the bonus.
4. Making minimum payments
Your credit card issuer only requires that you make small, minimum payments each month. While making these minimum payments can seem like you’re making progress on your debt, it’s a bad way to tackle your debt. You’ll end up paying a lot in interest over a long period of time.
How to avoid it: It’s best to pay off your balance in full each month to avoid paying interest. If you can’t make the full payment, pay as much as you can rather than just the minimum payment. Read our nine ways to pay off your debt in 30 days.
5. Overdraft protection
If you’re trying to buy something with your debit card and you don’t have enough money in your bank account, you could be hit with massive fees if you have overdraft protection. Overdraft protection allows you to still make that purchase — for an average fee of $35. Making things worse, most people who get charged an overdraft fee, rack up multiple overdraft charges each year. The CFPB found that people who have accounts with overdraft protection are three times as likely to have 10 or more overdrafts each year.
How to avoid it: Don’t opt into overdraft protection if your bank offers it. Or, use a bank account that offers fee-free overdraft, like SpotMe from Chime.
6. Home equity loans
With a home equity loan, you’re able to borrow money by taking out an additional loan against the equity that you’ve built up in your home. Home equity loans can be useful if you need to make home repairs. But, they can also lead you down a path of even more debt. For example, if you use your home equity loan to pay off high-interest credit card debt but then continue spending recklessly on your credit card, you may accumulate more debt.
How to avoid it: If you decide to use a home equity loan to pay off your high-interest debt, put a plan in place to ensure you stay debt-free. Stop using credit cards, change your spending habits, or start a new budget.
7. Long-term auto-loans
If you have your heart set on a new car that is outside your price range, the dealer might offer a creative solution: rather than paying off your car in 48 months, why not extend it to 72 or 84 months? Your monthly payments will become much more manageable, meaning you can get that brand new car into your garage today.
You may want to think again.
Car shoppers today are opting for longer loans, with 32% of new car buyers getting loans that are 73 – 84 months long — that’s six to seven years of payments. Yet, this is a bad deal for a number of reasons.
First off, you’ll end up paying more in interest. And, you’re more likely to be underwater on the car (which means you’ll owe more on the car than it is worth).
How to avoid it: While it can be tempting to get a more expensive car than you can afford and pay for it with a long-term loan, it better to simply buy a car with a shorter loan term. Better yet, pay for the car with money you’ve saved up for just this purpose.
8. Payday or title loans
Payday loans and title loans are short-term loans for small dollar amounts that come with extremely high-interest rates. With a payday loan, a borrower typically promises to repay the loan at their next payday. With a title loan, a car owner borrows against the equity they have in their car.
These are both often considered predatory loans — loans with unreasonably high-interest rates that aren’t in the borrower’s best interest.
How to avoid it: Finding extra cash can be tough. But if it’s an emergency, you might consider applying for a low-interest rate credit card or asking a friend or family member for a loan. If you need the money to pay a lender, consider asking for an extension.
9. Zero-interest financing
See something you want to buy but you don’t have the money to buy it now? Not a problem. There are so many options to buy now and pay later.
Yet, being stuck making payments on something that you can’t afford to buy in the first place isn’t a good idea. If you rack up too many monthly payments for things you don’t have the cash for, you run the risk of damaging your credit if you don’t make all the monthly payments on time. Plus, do you really want to be stuck making payments for months on something that you might not really want or need?
How to avoid it: Instead of planning to buy now and pay for something over time, save for it over time and buy it later.
10. Keeping up with the Joneses
Your neighbor gets a new luxury car. Your best friend took a 10-day Hawaiian vacation. Your co-workers treat themselves to sushi lunches. It’s easy to overspend when everyone else seems to be buying everything. But by trying to keep up, you could be doing damage to your long-term financial health.
How to avoid it: Remind yourself that it’s easy to see how much people spend, but it’s hard to see how much they save. Putting your long-term financial health first will leave you much happier in the long-run.
Avoid Debt Traps
As you can see, there are many debt traps out there, and they are easy to fall into. But, once you’re aware of them, they’re also easier to avoid.