Consumer Debt is at a Record High: Here are the 11 Types of Debt You Need to Pay Off First

CREDIT & DEBT - DEBT CONSOLIDATION
Not all debt is created equal, so it’s important to know which types to avoid. Here are the ones you want to keep away from.
Updated March 26, 2023
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The truth is that most people will have some form of debt throughout their lives. Some types of debt, like appropriately sized mortgage loans, can be beneficial.

But there are other types of debt that you probably want to prioritize getting out of, as these kinds of debt can make it very difficult for you to get ahead financially.

Here are 11 types of debt to avoid or pay off before they hurt your long-term finances.

Loans from your 401(k)

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If you have a 401(k) account, you’ve been working hard at planning for retirement. Every dollar you invest in the account is another dollar you can use at that time in your life. But here’s the thing — 401(k) loans are risky even if they don’t appear to be at first glance.

When you take a loan from your 401(k), you have to pay back the balance plus interest. There are no penalty fees for a 401(k) loan, but if you leave your employer during the loan period, you might have to pay back the balance quickly.

Fail to do so, and your loan could go into default. If that happens, you’ll have to pay taxes on the amount plus a 10% penalty fee. That’s not a position you want to be in.

Debt that you’ve defaulted on

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You can default on any loan, which makes this scenario dangerous for your finances. Even if personal finance experts consider the loan “good” debt, defaulting on it can drop your credit score and make it difficult to qualify for additional loans in the future.

But even beyond that, the lender can foreclose or repossess the collateral if it’s a secured loan, such as your mortgage. If the collateral doesn’t cover the loan balance, the lender could sue you for the remaining amount.

With an unsecured loan, the lender can sue and get a court order to garnish your wages. Neither outcome is positive for your well-being or overall financial picture.

Credit card debt with missed payments

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Your account can become delinquent if you’ve missed payments. Credit cards have relatively high-interest rates, so if your account is delinquent, you must pay late fees and interest rate charges. Plus, missed or late can negatively impact your credit score.

Balance transfer credit cards that you don’t pay in time

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Some credit cards offer balance transfers with introductory low annual percentage rates (APR). For people with multiple credit card balances or cards with exceptionally high interest rates, this can be a way to save money on interest fees or consolidate debt.

But suppose you don’t pay the balance off during the introductory rate period. In that case, you might find yourself with an even higher interest rate than you had before.

Payday loans with high fees

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Payday loans are notorious for offering some of the highest interest rates. Because of that fact alone, you may want to avoid this type of debt at all costs.

According to the Consumer Financial Protection Bureau, fees for payday loans can range from $10 to $30 for every $100 borrowed.

In other words, typical payday loans have interest rates of up to 400%. It’s one of the most expensive types of debt.

Student loan debt when you don’t utilize help

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Student loan debt might not top the list of worst types of debt. But if you’re not taking advantage of available government programs, then it might.

There are two types of student loans: federal and private. Federal loans are through the U.S. government and come with various repayment plan options and even forgiveness.

The programs depend on income, job type and other factors. Still, if you’re eligible and not taking advantage, you’re missing out on financial help.

Tax debt that you owe

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If you don’t pay the taxes you owe to the federal or state government, that balance becomes tax debt.

Tax debt is one of the worst types of debt because the balance rapidly accrues interest charges and other fees.

But even beyond that, the government can begin garnering your wages and take further action to ensure they receive payment. It can create a stressful environment that can feel difficult to fix. 

Prioritizing paying off this kind of debt can really lower your financial stress.

Title loans on your car

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Title loans are high-interest, short-term loans that require the title of your car as collateral. If you fail to pay the loan, the company can take ownership of your vehicle.

The interest rate for these loans is unlimited, meaning the loans usually have some of the highest rates.

Due to the lending terms and the possibility of adverse financial consequences, the state of California advises that consumers only utilize these loans as a last resort.

Loans from family members

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Unless the loan is a gift, loans from family members can get tricky. The downside of loans from family members might not be due to high-interest rates or fees like other loans on the list, but that doesn’t mean it’s a smart financial move.

Even with transparent terms and open communication, loans among families can strain relationships and even cause estrangement. Depending on your situation, they may not be worth the risk.

Auto loans that are bigger than necessary

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Auto loans are standard for many Americans, and the interest rates are typically reasonably low compared to credit cards and personal loans.

That might make it seem like auto loans are a wise financial decision. Still, if you take on an auto loan that is bigger than necessary, you might feel the financial strain.

This is especially true if your car depreciates drastically and becomes worth less than you paid or your financial situation changes while you’re in repayment.

Any debt you can’t afford

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Regardless of the type of loan or what you’re borrowing money for, it would help your situation if you avoided any debt that you can’t comfortably afford.

Whether it’s a mortgage payment or a payday loan, it’s probably a bad idea if you can’t make the payments without negatively impacting your finances.

This is equally as true if you’re borrowing money with a situation that isn’t stable or that you know is likely to change. You shouldn’t take on any debt unless you can comfortably still save and plan for a financial emergency.

Bottom line

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Keeping your monthly loan payments as low as possible is a good idea to provide flexibility and breathing room in your monthly budget.

After all, financial flexibility is one of the greatest gifts you can give your future self. You’ll be able to keep more money in your bank account and grow your wealth for the long-term.

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