Red flags of toxic debt and how to avoid it

The word debt can often have a bad connotation, but not all debt is necessarily “bad”. Certain types of debt, such as student loans and/or mortgages, allow you to use leverage to help improve your financial future. In addition, their 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 debt, toxic debt is a loan that is issued with a very high interest rate (usually a rate north of 30%). In other words, toxic debt is debt that is unlikely to be repaid with interest, a characteristic that can be particularly toxic for both lender and borrower.

“The loan will usually cost you significantly more than the value of the loan amount,” Trina Patel, financial advice manager for the personal finance app albert, says Select. Examples include payday loans or loans from predatory lenders that are characterized by unreasonable fees, rates and payments.

When you’re short on cash, payday loans seem like an easy solution because they can be a quick way to get the cash you need, but their interest rates are sky high. In some unregulated states, you could be paying over 500% interest for a short-term loan of a few hundred dollars, which quickly increases over time when you can’t pay off the balance.

Because toxic debt could wreak havoc on your finances without you even realizing it, we’re sharing signs below that you might already have it, along with tips for avoiding or getting out of toxic debt.

Are you making regular payments for a debt security, but the balance continues to grow due to a high interest rate? Patel points out that this is a sign that your debt is toxic, causing you to pay off an ever-accumulating balance and never get out of debt entirely.

A second sign, suggests Patel, is if your the debt-to-income ratio is high. This ratio indicates the amount of your debts in relation 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 salary is used to pay your debts.

To calculate your debt-to-equity ratio, divide your total monthly payments (credit card bills, rent or mortgage, car loan, student loan, payday loan) by your gross monthly income (what you earn each month before taxes and any other deductions). ). This calculation will naturally take into account the interest rate you pay on your various debts each month, so you can quickly see how it all adds up.

“The higher the ratio, the higher your debt, and you’ll want to take immediate action to pay off your debt,” says Patel.

Obviously you should try to avoid toxic debt at all times, but this may be easier said than done.

If you find yourself in a situation where you need extra money right away, Patel recommends first asking a family member or trusted friend to borrow money and creating a plan for it. repayment with him.

Another option is to subscribe to a personal loan from a bank or credit union. Personal loans often have lower interest rates than credit cards, and consumers can use them to finance almost any type of expense or to consolidate debt.

LightStream, for example, offers some of the lowest interest rate loans we’ve found when ranking the best personal loans, ranging from 3.49% to 19.99% fixed APR when you sign up for autopay. . Borrowers can even receive their funds the same day, if applied and approved on a weekday by 2:30 p.m. ET, and the loan terms are among the longest available, ranging from 24 to 144 months.

While LightStream requires applicants to have good credit or above, there are also personal loans for those with bad credit. Here are Select’s top picks:

If the above options aren’t viable, you can finally consider using your credit card, either by simply swiping it or taking a cash advance (cash advances usually have a fee of around 5 % or more, note that you will start charging interest immediately on the cash advance). Although credit cards have some of the highest interest rates, they’re still cheaper than what you’d pay if you took out a payday loan you can’t afford to pay back.

In this scenario, Patel suggests talking to your credit card company about lowering your interest rate. You can also consider getting a low interest credit card or a credit card with a 0% APR introductory period like the U.S. Bank Visa® Platinum Card, which offers one of the best overall intro APR periods: 0% for the first 20 billing cycles on balance transfers and purchases (after, 15.24% to 25.24% variable APR; cardholders must complete balance transfers within 60 days of account opening). This is one of the longest interest-free periods for balance transfers and purchases. With such a long introductory period, ideally you can pay off your debt within that time frame and not have to pay any additional interest.

“With all of these options, it’s important to create a plan to pay off that debt,” says Patel. “I would also recommend reviewing your budget to see where you can cut expenses and start building an emergency savings fund to avoid this in the future.”

And if you already have toxic debt, prioritize action to eliminate it completely. Patel suggests starting by talking to a credit counselor who can help you explore your options. The most reputable credit counseling organizations are non-profit organizations and you can take advantage of their programs for free or at an affordable flat rate. You won’t pay high fees to meet with one like you would with a financial advisor.

To get started, find an accredited credit counseling agency in your area on the FCAA website or by phone at (800) 450-1794. You can also search on NFCC website (search by zip code below), or call (800) 388-2227.

Check out Select’s in-depth coverage at personal finance, technology and tools, welfare and more, and follow us on Facebook, instagram and Twitter to stay up to date.