Unfortunately, not everything is simply a matter of cash or credit. With the wrong financial advisers or a bad financial background it is possible to get bad terms on your credit.

This can be a difficult position to get out of. If the problems that led to getting bad terms still exist, it will be difficult to find a way out that only includes good credit terms. Do the right things with your debt and it will eventually be possible to get good credit loans and terms even if all you can get approved for are bad credit loans and terms.

Bad credit terms can exist in a lot of ways. Here is a partial list with information on what you can do about them.

Prepayment penalty

This often caps off bad credit loans. Lenders who put this clause in their loans do so because they know how much of a good deal it is for them. They want you to be stuck in that loan for as long as possible so that they can make the most money off you. There are three ways out:

• Wait it out. If the term of the credit is short enough, you can make the payments until the prepayment penalty expires. Then refinance into a loan with more favorable terms.
• Refinance now. You will have to pay the prepayment penalty, but if you can get a more favorable loan by refinancing, the improvements in the terms may exceed the cost of the penalty. Try Bankrate’s Refinance Calculator (or any of the other 500,000+ such calculators out there). That calculator can be used for non-mortgage loans if you leave the correct valuesat zero.
• Negotiate. It will probably not work, but it cannot hurt to ask the lender if they will remove or reduce the prepayment penalty on the loan.

High interest rates

In general, a high interest rate is anything above 10%. Credit cards are almost always in this category. Even home mortgage rates have been above this threshold – even for prime borrowers. Most of the time however, any asset-backed loan (home mortgage, home equity line of credit or auto loan for example) should be below this rate.

• For any loan with an asset as collateral, try to refinance the loan to get a more favorable interest rate.
• For non-collateral loans, such as credit cards, it is often cheaper to get a better interest rate. You will probably not get a long term rate below 10%, but just by threatening to move the debt to a different credit card or to open a line of credit elsewhere, many companies are willing to offer you a reduced rate to stay. {No Credit Needed Blog} covers doing this in Call for Discounts.

Balloon

A payment balloon is simply one or several large payments to be made at the end of the loan. This is done to allow for a lower payment up front. This is favorable to the lender for two reasons.

First, the principal amount of the loan shrinks slower. This causes more interest to accrue over the life of the loan.

Second, if the economy is in a recession or the borrower has difficulties, the loan is unlikely to be paid off at the end, and the lender will either get to make another bad terms loan or will get possession of the house or car that was financed.

Negative Amortization

Negative amortization happens when the monthly payment is lower than the amount of interest that in generated each month. In other words, the loan gets bigger with every payment made. Eventually something will break. The loan must be refinanced or the monthly payment will have to suddenly grow much larger – large enough to pay off the loan in a compressed time frame plus the extra interest accrued.

Since negative amortization loans are generally used when somebody will not otherwise be able to get a loan, the refinance or larger payments usually becomes a financial disaster. These types of loans are a part of the sub-prime loans that are creating a crises in the American housing markets right now.

Extended Repayment Period

A loan that is financed over a longer than normal period of time is a great thing – for the lender. It secures payments for more years than normal, often at a higher interest rate, for only a small savings in monthly payments. No matter who tells you to do it, paying for a house over 40 or 50 years is not a good idea.

Conclusion

There are other terms that can be harmful to your financial health. The key is to carefully consider the downsides of any credit that you are offered before accepting and to not give in to a hard sell tactic, especially if it is designed to get you to ignore or treat the condition as minor. If it was that minor, it would not be in the contract.

If there are any in particular that you would like more information on, feel free to add a comment and ask. If you want more detail on any particular term listed above, I can get it for you as well.

Here is a short post from Debt Consolidation Lowdown called Live Within Your Means that touches on a similar topic.

Motive is the greatest and most difficult source of bad debt to solve. We all have reasons, usually completely defensible to ourselves, on why we have taken on each and every bit of debt that we have. The problem with this is it allows our creditors to control our lives because we have to work to pay them off.

I am not going to go extreme and say that all debt is evil. It is not, but most debt for the average consumer is not good for them. With the exception of homes, most credit is received to purchase items that lose value over time. For credit cards, personal loans, and even some car loans the benefit does not last as long as the payments do.

Here are some of the motives that we use to justify taking on more debt:

• Habit
• Supersizing
• False Economy
• Sales
• Matching Friends
• Convenience

Each one of these examples is a bad motive for incurring debt. Whenever one of these reasons justifies taking on debt, the reasoning is flawed. It may take time, but almost everybody should be able to live without taking on any debt that does not help you reach your financial goals. The only exception that comes to mind are medical related debts – and that is a huge topic by itself.

If you look at this list of habits, there is really one theme that ties them together. They all encourage spending beyond your income – AKA Living Above Your Means.

• Habit is about doing the same old thing. For somebody to stop this, they have to recognize that what they have been doing is bad. Then they can figure out the alternative.
• Supersizing is known by salesmen as the upsell. The most common example is fast food restaurants. The regular meal is at best the maximum amount of food somebody should be eating. Upgrading to the larger sizes though only costs a few cents. So millions of people do it daily, enlarging their bodies and shrinking their wallets. Just say no.
• False Economy can happen two different ways:
  • Buy something that is cheap and have to replace it when buying a higher quality would have cost less to begin with.
  • Buy something expensive that is overkill – where the inexpensive version would have done just as well.
• Sales tug at us all. For something needed – or saved for – a sale is a great thing. It is when the sales induces buying more stuff that there isa problem. If there is no need for it, something is not a bargain no matter what price you pay.
• Matching Friends happens when being around friends changes behavior. Salad and bread sticks when solo becomes steak and wine with friends. This throws the budget out the window and is an easy way to run up the debt. The worst part is that some people not only try to match their friends, but they want to beat the neighbor – who is still a stranger – down the street.
• Convenience happens. It is easier to get something now, or to buy something because you are out even if there is no cash to pay for it. The credit card comes out and the cha-ching of the register is money flying out the door. Even small things add up because businesses exist solely to conveniently meet people’s desires.

Here is an example to see how easy it is to trip up in the motivation department. I know I can attest to having done most or all of these in the past.

ExJackly is hosting a poker night for his 3 friends.
1. He goes to the store to get some wine and beer and snacks like normal.
   While there, he finds the chips are $3 per bag or 4 for $10. He grabs 4 bags.
2. Remembering that Mattly broke a couple of poker chips last time when his chair rolled over them, Exjackly picks up a new set of casino-grade and weight chips.
3. On the way home, he fills up on gas and because of the $2-off a deluxe car wash, he gets the car cleaned.
4. That night, after the game, Exjackly is tired and ready for bed as he shows his friends to the door. One of them asks if Exjackly wants to come with them out to the local diner for a late night meal. Exjackly decides not to disappoint and joins them. At the diner, there is a special on the shrimp cocktail which everybody decides to get.

How many bad financial decisions did Exjackly make? Which ones were they and why?

The trick to avoiding these motivational issues with debt is to alter how we think about money to begin with. It takes time, especially for somebody who is currently in debt already. For anybody who is serious about avoiding bad motivational debt, it is possible.

1. Do not be afraid to be different. Choosing a lifestyle without debt will mean acting differently than friends and family. This is especially true at the beginning when there is bad debt being eliminated.
2. Budget and stick to the budget.That means giving credit to your budget busting activities and choosing to make them fit the budget instead. Stick to it.
3. Say NO and suggesting affordable alternatives. This could be as easy as hosting a potluck instead of going out on the town. It could be as difficult as convincing yourself and your spouse that the 1993 Volvo station wagon is a better vehicle than the 2008 Ford Mustang.
4. Put all non-accounted for funds towards eliminating bad debt. Do not drain emergency funds or short other budget categories. If the money is not planned for use elsewhere, do not spend it elsewhere. If it is not spent elsewhere, it can be spent on eliminating debt.
5. Operate on a cash basis. Do not carry around wads of cash. Instead, just work to not spend money until you have it available.

Spend the correct amount of time doing this, and bad debt will be a thing of the past. Even better, new habits will be established that will discourage bad decisions in the future.

Bad Debt can have a lot of elements that make it bad. Sometimes it is just one reason that makes us consider something Bad Debt. Other times, there are multiples reasons. The reason why something is bad has a lot to do with what it will take to fix it and even more to do with how to avoid the problem in the future.

It is especially important to note that whether something is Bad Debt or not is strongly dependent upon a person’s situation. The exact same debt for two different people can be Good for one and Bad for the other. As we go through the categories below, the reasons this is true should become clearer.

I’ve loosely organized these reasons into 3 categories:

• The Motivation Behind Bad Debt
• The Terms of Bad Debt
• Too Much is Bad Debt

• Good debt vs. bad debt at Money.com. This link covers the platitudes, saying that good debt is for what you ened but cannot pay cash for while bad debt is for anything that you do not need; despite not telling you how to figure out if something is a need or a want.
• Good debt and bad debt at Bankrate is a much better article. This article points out that good debt helps to make you wealthy but still sticks with generalities like “Mortgage debt is good debt” (it is not always). Same article is also at MSN as Good debt versus bad debt.
• Garden and Hearth also talks about Good debt vs. bad debt. Their article lists out the key points (good terms, purchasing an asset, etc.) that differentiate good reasons for taking out a loan from bad.
• My Financial Awareness revisits the topic with A New Look at Good Debt vs. Bad Debt. This new look emphasizes that once you have the debt, it does not matter why you got it: debt is debt and needs to be dealt with regardless of how you incurred it.
• On the Rule #1 Blog, Phil Town elaborates on a reader’s question in GOOD DEBT, BAD DEBT. This post is a good one that shows how to tell if a mortgage is a good debt using a positive example.
• There is Freedom in the Hills of New Hampshire to discuss Good Debt vs. Bad Debt. This is different from the rest because it discusses how any debt can be considered bad, but mentions how credit cards – for all that is bad about them – can still help “smooth” out one’s financial life.
• Queercents get personal in Almost Debt Free: Good Debt vs Bad Debt. The key point here is in his discussion about student loans where he points out that some of it is good, and some of it is not so good.

Reading through these articles, and all of the others you can find with a simple Google search (or Yahoo! or MSN), you start to get a sense that there is a wide gamut of opinions on the value of debt. This is true because there is a wide range of tolerance for risk. {No Credit Needed Blog} has done well for his family by attacking debt and eliminating it from his life. Others, like Donald Trump (see wikipedia) have used massive amounts of debt to reach their goals.

In the end, regardless of where on the spectrum that you are, the decision on if a particular debt is a good one is one that you will have to make. Use the general guidelines about using loans for assets and leverage, but do not take on any debt – even if it is otherwise ‘Good’ debt – unless you are comfortable doing so and do not take on more than you need to reach your goals.

Good luck, and may all of your financial goals be reached while you enjoy the rest of your life.