Few of us go through life without ever applying for loans or borrowing money. Borrowing and repaying money can help you establish a credit history that will make it easier to get financing when you need it. But it's important to use credit judiciously, so it can help, rather than hurt, your finances.
These examples help illustrate the difference between "good" and "bad" borrowing practices.
Good times to borrow
- You're buying a home. To make a home purchase, most buyers need a mortgage loan. This type of financing is often considered good debt because a home is an investment that's anticipated to increase in value over time. The caveat? Look at your entire financial picture before taking on a home loan, and make sure you're buying a home you can truly afford.
- You're adding to your education. If you're finishing up an advanced degree or need additional training to move ahead in your career, taking out a student loan can be a smart move. Shop around for the most favorable rates and repayment plan.
- You're setting up a household. You'll need some basics to begin with, such as a bed or a refrigerator. Essential appliances and furniture often can be purchased via installment financing through the store — but don't overdo. Not everything in your first place needs to be new. Thrift stores, yard sales and family members can be good sources of basic furnishings that tide you over until you can afford the items you want.
- You're consolidating debt. If you have several credit cards with high interest rates, it may make sense to get a loan to achieve a lower overall interest rate and smaller payments. But note: Put those cards away. Don't rack up new charges as you're paying off the consolidation loan.
Good times to wait
- You want to buy extravagant holiday gifts. It's never a good idea to borrow money — either through a loan or on your credit card — to spend above your means. Temper your generosity and choose meaningful, less expensive ways to remember others at the holidays.
- You'd like a nice wedding. Taking out a loan to put on a lavish ceremony and reception that you can't truly afford could start your marriage out behind the financial eight ball. Scale back your plans to fit your budget and focus more on the occasion than the show surrounding it.
- You need a vacation. Travel typically costs more than you think it will, and if you have to take a loan simply to go on the trip, you're better off finding more affordable ways to relax and recharge.
Good rules of thumb
- Borrow only what you need.
While it's tempting to borrow more, you'll end up having more to pay back and risk undermining your budget.
- Shop around for good rates.
Compare interest rates and payment terms. If you have a good credit score, you may be able to negotiate a better offer.
- Pay off credit card balances every month.
Carrying a balance means you'll pay more for every purchase you make, in the form of interest charges on the amount.
- Check your credit report once a year. Knowing your credit score may help you secure more favorable rates.