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The word debt can often have a negative connotation, but not all debt is necessarily “bad.” Some types of debt, like student loans and/or mortgages, allow you to use leverage to help improve your financial future. Plus, its low interest rates allow you to take advantage of cheap financing over time.
At the other end of the spectrum is what we call “toxic debt.” Unlike low-interest rate debt, toxic debt is a loan that is issued with a significantly high interest rate (typically a rate greater than 30%). In other words, toxic debt is one that has little chance of being repaid with interest, a characteristic that can be particularly toxic for both the lender and the borrower.
“The loan will usually cost you a lot more than the value of the loan amount,” Trina Patel, manager of financial advice for the personal finance app. albert, tells Select. Examples include payday loans or loans from predatory lenders characterized by unreasonable charges, fees, and payments.
When you’re short on cash, payday loans seem like an easy fix, as they can be a quick way to get the money you need, but their interest rates are exorbitantly high. In some unregulated states, you may pay more than 500% in interest on just a short-term loan of a few hundred dollars, which grows rapidly over time when you can’t pay off the balance.
Because toxic debt could be wreaking havoc on your finances without you even realizing it, here are signs you may already have it, plus tips for avoiding or getting out of toxic debt.
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Signs that you may already have toxic debt
Are you making steady payments on a debt obligation, but the balance continues to grow due to a high interest rate? Patel points out that this is a sign that his debt is toxic, leaving him stuck paying a balance that builds up forever and never fully rids himself of the debt.
A second sign, Patel suggests, is if your debt-to-income ratio is high. This ratio shows how much debt you have relative to your income. While a low debt-to-income ratio indicates that you earn more than you owe, a high ratio means that more of your paycheck goes toward paying down debt.
To calculate your debt-to-income ratio, divide your total monthly payments (credit card bills, rent or mortgage, car loan, student loan, payday loan) by your gross monthly earnings (what you earn each month before taxes and other deductions). ). This calculation will naturally take into account the interest rate you pay on your different debts each month, so you can see how it all adds up quickly.
“The higher the ratio, the higher your debt obligation, and you’ll want to take immediate action to pay off your debt,” Patel says.
Tips to avoid or get out of toxic debt
It’s obvious that you should try to avoid toxic debt at all times, but that’s easier said than done.
If you find yourself in a situation where you have an immediate need for additional cash, Patel recommends first borrowing money from a trusted family member or friend and creating a payment plan with them.
Another option is to take a personal loan through a bank or credit union. Personal loans often have lower interest rates than credit cards and can be used by consumers to finance almost any type of expense or to consolidate debt.
light flow, for example, offers some of the lowest interest loans we found when ranking the best personal loans, ranging from 3.49% to 19.99% fixed APR when you sign up for auto pay. Borrowers can even receive their funds the same day, if requested and approved on a business day before 2:30 p.m.
Annual Percentage Rate (APR)
3.49% to 19.99%* when you sign up for autopay
Purpose of the loan
Debt consolidation, home improvement, car financing, medical expenses, weddings and others
While LightStream requires applicants to have good credit or better, there are also personal loans for those with bad credit. Here are the best Select options:
If the above options aren’t viable, you might finally consider using your credit card, either by simply swiping it or taking out a cash advance (cash advances usually have a fee of around 5% or more, be aware that they will start to charge you immediate interest on the cash advance). Although credit cards have some of the highest interest rates, they are still less expensive than what you would pay if you took out a payday loan that you can’t afford.
In this scenario, Patel suggests talking to your credit card company to lower your interest rate. He might also consider taking out a credit card with a low interest rate or a credit card with a 0% APR intro period like the US Bank Platinum Visa® Card, which provides one of the best introductory APR periods overall: 0% for first 20 billing cycles on balance transfers and purchases (thereafter 15.24% to 25.24% variable APR; cardholders must complete balance transfers balance within 60 days of account opening). This is one of the longest interest-free periods for both balance transfers and purchases. With such a long introductory period, you can ideally pay off your debt within that time frame and not have to pay additional interest.
“With all of these options, it’s important to create a plan to pay off this debt,” says Patel. “I would also recommend reviewing your budget to see where you can cut back and start building an emergency savings fund so you can avoid this in the future.”
On US Bank’s secure site
0% for the first 20 billing cycles on balance transfers and purchases
15.24% – 25.24% (Variables)
Balance Transfer Fee
Either 3% of the amount of each transfer or a minimum of $5, whichever is greater
Foreign transaction fee
Consider a credit counselor to develop good financial habits
And if you already have toxic debt, prioritize taking steps to eliminate it entirely. Patel suggests starting by talking to a credit counselor who can help you explore your options. Most reputable credit counseling organizations are non-profit organizations and you can take advantage of their programs for free or at an affordable fixed rate. You won’t pay high fees to meet with one, like you would with a financial advisor.
To get started, find a reputable credit counseling organization in your area at FCAA website or by phone at (800) 450-1794. You can also search the NFCC website (search by zip code below) or call (800) 388-2227.
Editorial note: Any opinions, analyses, reviews, or recommendations expressed in this article are solely those of Select’s editorial staff and have not been reviewed, approved, or otherwise endorsed by any third party.