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The 5 Worst Forms of Debt

I suppose you could live your entire life without going into debt, though modern middle class society in the United States seems to be designed to require at least some debt. Even if young adults can complete their education without taking on student loan debt, just about all new homeowners need a mortgage in order to afford a house. In some cases, debt is just a cost of middle class living.

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Some debt products should just be avoided, however.

1. Payday loans. To qualify for a payday loan, you would need to prove a history of income. The will would provide you a short-term loan, with the balance and fee due within weeks. Those fees could be $15 to $30 for every $100 borrowed, which on a two-week loan could be considered a 390% interest rate. If you aren’t able to pay off the loan when it is due, you can renew it for an additional fee.

Most people who take out payday loans fall into a cycle of debt, renewing their loans or going back to the lender often. It’s rare that someone in a short-term financial fix borrows money at a high rate for a few weeks and pays the loan off in full.

2. Refund anticipation loans. These were marketed heavily a few years ago, and now that we’re heading into tax season it’s likely we’ll see more ads. Refund anticipation loans are often offered by the same company you might use to help file your taxes. If your income tax return forms show that the government owes you money, for a fee, these companies will be willing to offer you your anticipated cash now.

You can adjust your tax withholding at your job to make sure you’re not due a large refund when you file your taxes. There are few good reasons to keep paying the government more than you need to every week or two when you receive your paycheck. The “forced savings” rationalization is not a good reason.

3. Gambling. For the sake of your kneecaps, you don’t want to find yourself in debt to a bookie. Movie drama aside, gambling is always a losing endeavor in the long run. It can be an addiction, so seek help if gambling is controlling your life. One problem is sunk costs. Once you start losing, you want to make up for your losses, taking larger risks.

If you’re a stock trader relying on the margin for making purchases, you might as well be gambling.

4. Rent to own. If you have young children in school beginning to learn to play a musical instrument, you are likely encouraged to rent the instrument from the store. The rental programs are generally designed to either buy the instrument after some time or return the instrument to the store when the student loses interest. This is the best rent to own scenario.

Once you start renting electronics and furniture, you will generally get a bad deal. It’s likely you’ll pay much more than the cost of the product by renting, and you will likely be charged a high rate of interest.

5. Debt used to finance a depreciating asset. One rule of thumb dictates that debt should only be used to pay for an asset that increases in price. For that to make sense, the price of the asset should increase at a rate higher than the rate of interest on the debt. The only problem is that you can’t consistently predict whether the price of an asset will increase.

Cars, unless they are collectible items, would not qualify under this rule. I would argue that if you need a car to earn money, the benefits of its use might outweigh the cost of the loan. And even a reliable used car could cost more than someone on the first day of his first job might be able to afford.

A few years ago, I knew many people who thought that real estate prices could never go down, conveniently excusing the fact they had no equity in their house. Banks were eager to let them buy their houses with hardly any down payment. If they were forced sell after their house values dropped 20%, they would be in financial distress. And worse, if they were no longer able to afford their mortgage, they might have to foreclose.

What other forms of debt should people avoid?

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Photo credit: Dan4th

Updated October 21, 2015 and originally published January 21, 2010.

About the author

Luke Landes is the founder of shizennougyou. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 11 comments… read them below or add one }

avatar 1 Anonymous

I’d broaden #5 to include debt you incur that does not even get you a depreciating asset like financing vacation on a credit card.

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avatar 2 Anonymous

#1 is bad debt no question
#2 is bad, sure, but you didn’t really address why the debt is bad (you only talked about why getting a refund is bad.) RALs are another type of overly expensive debt, as typically the refund would come in two weeks or less anyways.
#3 Gambling isn’t a type of debt.
#4 Nor is a “rent to own” plan a type of debt, really. Just an expensive way to purchase something.
#5 Isn’t a “form” of debt, just a blanket statement.

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avatar 3 Anonymous

Steve, gambling itself might not be a debt, but going in to debt in order to gamble might very well be the dumbest thing one can do, financially. That’s what the article’s warning about–not the gambling itself (although it’s certainly not recommending such activities), but gambling with money you don’t have.

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avatar 4 Luke Landes

Thanks for the clarification, A.J. Many people who gamble, particularly those who do compulsively, will find themselves in debt before long. And if credit is given to you by unscrupulous individuals, perhaps some gamblers’ only options, then you’re asking for trouble down the road.

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avatar 5 Anonymous

I’d put money owed to the IRS in there above #5. You do NOT want to owe the government money. THey won’t bust your knee caps but they can put you in jail worst case.

I’m not even clear on what they are saying for #5. Cars are the obvious depreciating asset that people get loans for but they seem to say cars don’t count there. But then they talk about houses losing value. Is #5 meant to cover houses but not cars? Or what?

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avatar 6 Luke Landes

Cars are certainly depreciating assets, so the best choice is to not go into debt to buy one. However, I can see circumstances where a reliable car is a necessity, even if someone hasn’t had a chance to save up money.

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avatar 7 Anonymous

I really hate those any type of loan that takes advantage of people – like the payday loans or refund anticipation loans. typically those loans end up being extremely high interest – and taking advantage of people who really can’t afford those types of loans..

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avatar 8 Anonymous

Just thinking….
It could be argued that *too* much school loan debt can be right up there with these other 5 “worst” debts. Too much in school loans (ex. $50K+) will seriously hinder your future financial cash flow. School loans don’t always lead to high-paying jobs. Plus…you can’t get out of it by declaring bankruptcy. All these other debts you can potentially be elimanated by bankruptcy; but not school loans.

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avatar 9 Anonymous

Sometimes some depreciating assets such as a car or new clothes for a new job are important for producing money, for your income, so in some cases you should decide wether you may be in debt for income or stay without the new or higher income to stay debt free; I see the problem should be take the risk or be in debt after exploring all posibilities and find no option, and of course buy a car for your job does not mean a 2010 Mercedes, could be a used car yoi can afford. Another topic is how we can see todays consumism in families and how we assume as a true that our parents or grandparents had an easier life before so that they could have assets that we could not afford if we do not enter ito the cycle of debt; 2 things for that: 1, today we only understand we enjoy life eating out, paying for places to enjoy and go shopping; 2 is that when people today is 30 we think that in order to live we need to have the same standard of life as our parents have, and they are already 60, so they have their standard but worked 40 years to have it and we have worked only a few years, so we get in debt

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avatar 10 Anonymous

Payday lending opponents’ “cycle of debt” claim is not valid CFSA’s Best Practices indicate that any customer who cannot pay back a loan when it’s due has the option of entering an extended payment plan. This option allows them to repay the loan over a period of additional weeks at no additional cost.

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avatar 11 tigernicole86

Sometimes, there are certain things necessary to gain a new job like Auturo said. But i have found that with trying to find new furniture,the RTO places are bad news. I need a new bed but my back can take it for a few more months rather than pay about 2x as much for a bed even if I paid everything up front.

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