As a general principle, debt is bad unless

• It’s an investment debt, examples of which are,
  • education loans in an area and, in an amount that makes economic sense
  • a mortgage,
    • a loan to purchase a house or real estate,
      • for which at least you have a real asset to sell off later,
      • it can be viewed as a form of saving at the least;
      • you may be able to build equity over time, and thereby
      • to increase your net assets position; or
  • an asset that will produce returns
    • greater than the cost of servicing the debt,
      • i.e. your earnings on the asset is greater than interest paid on it;
    • for example, a business or some form of an investment instrument
      • that produces an additional and an ongoing stream of income.

Long Term Loans,

• credit cards, education loans, business loans, mortgage loans etc.
• even for ‘good investment loans’ (debt) have one trap:
  • the ‘Minimum Monthly Payments’ trap.
• ‘Minimum Monthly Payment,’
  • is the amount you are required to pay on your outstanding balance
    • at regular periods (usually monthly, but also quarterly, yearly, etc.)
    • over the life of the loan;
    • meant to at least cover the interest on the loan.
  • But it may not cover your total monthly interest,
    • which means the amount you owe could be increasing
      • even while you are making regular payments!
• When you take out a loan, your loan balance
  • which is your total debt on the loan,
  • continues to earn interest,
    • by the day, month, etc. depending on the loan details; it may also
  • increase when you fail to make a payment
    • because you get charged a penalty for late or non-payment,
      • which is then added to your loan balance!

 If your minimum payments do not cover the interest,

• • in each period,
  • the unpaid interest is usually added to your outstanding balance
    • (this is called ‘capitalization’ of the interest)
    • that is, it’s like you took a larger loan in the first place;
  • future interest payments may be calculated on
    • the unpaid interest plus the original balance (‘principal’);
    • which is now the new and higher ‘principal’,
    • therefore your debt is growing, even as you are making
      • regular payments towards it!

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• Example, say you hold a balance of $25,000 on a credit card/loan
  • at 15% annual interest rate computed on each month’s balance, you must pay
    • $3750 per year in interest (25,000 x 0.15) or
    • $308 – $312 per month (3750 /365 * 30 days; or $3750 /12 months) or
    • $500 per month if the minimum payment required is 2%
      • ($25,000 * 0.15)
  • If you miss one minimum payment,
    • the $500 may be added to your balance of $25,000
      • at the end of the period
      • to become $25,500.
      • Your annual interest at 15% is now
        • $3825 per year (25,500 * 0.15) or
        • $314 – $318 per month (3825 /365 * 30 days; or $3825/12 months) or
        • $510 per month if the minimum payment required is 2%
    • Additional fees (penalties) may also be added to your loan balance.
  • If on the other hand
    • you are in financial difficulty and ask for reduced payment
      • that is less than your interest payments,
        • say you want to make a $100 payment,
        • instead of the minimum payment of $500
      • you will be paying less than the interest payment
        • (of $308 – $312 per month);
      • your outstanding interest may be capitalized
        • i.e. added to the initial balance of $25,000:
        • which is $208 – $212: the difference
          • between your monthly interest
            • ($308 – $312) and
            • the $100 you paid
        • will be added to your balance;
        • other ‘late penalty’ or ‘non-payment’ fees
          • may also be added to your balance
        • other ‘finance’ or ‘financing’ charges
          • may be added to your balance and
        • the total loan balance will increase.
      • Then what looks like a relief (less than the minimum payment)
        • turns out to be bad for you in the long run

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