Good loans
Good loans are loans that you take out to benefit yourself individually, professionally, or out of necessity.
These loans are not used to finance expensive discretionary spending (i.e. fancy cars and vacations). Examples of what we believe are good loans are student loans and mortgages on your primary residence. Let’s explain.
Student loan
A student loan is a good loan in our opinion since you are bettering yourself by going to college or a trade school to learn a skill and hopefully get higher compensation. Plus, if you are under 25, you have many years left of work to pay your debts back even if the career choice does not work out.
Mortgage
A mortgage payment is the second good loan we believe since you need to live somewhere and you might as well put your money to work by putting it into a piece of real estate. There are certain exceptions for this and one should consult their professional advisor for the best course of action to take for their needs. However, usually, if you are going to live someplace for less than 4 years, it pays to rent. If you are going to live someplace for 5-10 years, or longer, it pays to buy. This is because over time, real estate tends to increase in value and your mortgage payments go towards the value of the real estate, as to when you pay rent, your rental payments go out the window into some else’s pocket.
Bad loans
We believe that a bad loan is one which was taken out to finance your lifestyle when your cash flow cannot afford it. If you make $50,000 per year, and spend $60,000 per year, you are cash flow negative and need to get the extra money from somewhere. Many times, individuals will take out a second mortgage or a HELOC (home equity line of credit) on their house to pay for bills. This goes against everything that we try and teach.
Budgeting
Making a budget is one of the most important things you can do to take control of your money. This allows you to keep track of your income and expenses. By painting this financial picture on a weekly, monthly, and/or yearly basis, it gives you the power to control where you spend your hard earned cash.
Structure of budgeting
There are a few steps needed to make your budget.
- Figure out how much you make for the period
- This is all sources of income including salary, bonus, commissions, interest, etc.
- Estimate your hard expenses for the period
- These expenses are your necessary expenses you have to incur.
- Examples of these are your rent, telephone, utilities, and groceries (not including entertainment!)
- Estimate your soft expenses for the period
- These expenses are your discretionary expenses you want to incur.
- Examples of these are your vacations, fancy car, cell phone, going out to dinners, movies, etc.
- Review the period and compare actual to expected results
- This is arguably the most important of the steps. You must compare the actual vs. expected results so you can see where you must adjust going forward.
It cannot be stressed enough that you need to run your own calculations because companies, large and small, as well as banks, make mistakes. After all, they are all run by humans. Make sure you always keep track how many hours you work and what your hourly rate is so you can calculate how much money your employer owes you. This allows for better control over your budgeting process (see Financial Concept #1). Remember this is your gross amount due, not what you will be depositing into your account (the difference being taxes and withholdings).