Debt Basics
When dealing with debt, it's important to recognize that there are various types and they won't always result in the same outcome. For example, going into debt for school or business purposes or taking out a loan for real estate (such as a mortgage) could be considered investments that might yield greater financial earnings for you in the future. This kind of debt may be costly in the short term, but could potentially end up paying for itself in the long term if it's an investment in an asset such as education or real estate. However, debt that does not invest in anything is simply a financial burden in both the short term and the long term. This is the kind of debt that must be managed carefully to avoid letting it quickly spiral out of control.
No matter how much or what kind of debt you take on, it's essential to have a solid repayment plan. Since interest compounds over time, the amount you have to pay off can quickly get out of hand. When handling debt, it's always best to pay it back as quickly as possible.
The Power of 50
This financial formula helps you pay off your debt faster. Let’s say that you have a AED3,000 debt at an annual interest rate of 18 percent. If you make the 2 percent minimum monthly payment of AED60 per month, it will take you eight years to pay off your bill — assuming you don’t continue to spend any more money during that time. By the end of the eight years, you will have paid AED5,760 — almost double the initial AED3,000. By paying an additional AED50 per month, you can pay off your debt in three years instead of eight, which saves you over AED1,800 in interest. The bottom line: paying off your debt sooner rather than later saves you money.
The 28/36 Rule
Another helpful guide is a rule mortgage lenders use: the 28/36 rule. It stipulates that your housing payments shouldn't exceed 28 percent of your gross monthly income, while your total debt service — including your house payments, utilities, credit cards and other loans — shouldn't be more than 36 percent.
Types of Loans
- Student Loans – If you need to borrow money to cover your college tuition, you normally take out a student loan. There are a few options for what kind of loan you would apply for, including federal loans as well as loans from private companies.
- Mortgage Loans – Buying a home can often require applying for a mortgage loan. Different interest rates and repayment times can greatly affect a mortgage loan's impact on your finances.
- Auto Loans – You are able to buy and finance a car through auto loans from car dealerships, bank, and credit unions. You may also take out a home equity loan, which allows you to use your home as collateral for your auto loan.
- Personal Loans – A personal loan can be used to cover various costs, from repaying credit card debt to taking an expensive vacation, at your discretion. Personal loans can be secured or unsecured, depending on whether you have collateral and the risk you want to take.
- Peer-to-peer Loans – You can use an online service to match up with a peer lender, whether you want a loan for personal purposes or your business. Many of these loans are unsecured, and since operations are conducted entirely online you should approach peer-to-peer loans with caution.