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3 Types of Debt You Never Want to Have

Debt is a problem for many Americans, but some types of debt are much more harmful than others. Knowing which types of debt are most harmful to your finances is important when it comes to controlling interest expenses and keeping debt under control.

Payday loans
When it comes to interest rates, payday loans are about as bad as they get. Annualized rates can easily move into the triple-digit range, sometimes moving as high as 500%. On top of that, payday loans come with extra fees that increase costs for borrowers even more.

Flickr / taberandrew.

If these loans are used for the short term, they still cost more than other lending options, but the cost is not as much as if they were used for an extended period of time. However, for many individuals, this is not the case. According to the Center for Responsible Lending, "The average payday borrower has nine transactions per year." Moreover, "Loans to non-repeat borrowers account for just 2% of the payday loan volume."

Although payday loans can seem like the easy solution to covering expenses, there are many better alternatives. Many community banks and credit unions offer short-term loans to cover expenses and do so at rates far better than payday lenders. Some borrowers may also want to consider borrowing from friends and family if it's only for a short period of time. Even though it may be a hassle, few friends of family members will charge triple-digit interest rates.

Credit card debt
There are situations where credit cards are a financially beneficial tool, but credit card debt is among the worst things to carry over time. With many credit cards nearing a 30% interest rate on carried balances and most others carrying at least double-digit interest rates, these debts grow quickly if not paid off.

Flickr / Sean MacEntee.

Consider also that getting rid of credit card debt is a good financial investment. By paying down this debt, you would effectively be earning up to 30% per year on the debt paid down. Even famed investor Warren Buffett is proud of earning an average of 20% per year from his investments.

Credit card debt can arise from a number of scenarios, but too often it comes from irresponsible spending and a pay-it-off-later attitude. While not as expensive on an annualized interest-rate basis as payday loans, credit card debts pile up fast and can lead to much greater expenses down the road.

Unpaid taxes
Few people like to pay the taxman, but not doing so can land you in another heap of financial trouble. As it turns out, the IRS wants what it's owed and is ready to act accordingly.

Through a sea of penalties and interest, those who don't pay their taxes on time and in full can see their debt to the IRS skyrocket. In fact, the IRS even admits that in certain cases, "The interest rate on a credit card may be lower than the combination of interest and penalties imposed by the Internal Revenue Code."

It's also important that you file your tax returns even if you can't pay in full. Not only can refusing to file a tax return potentially increase penalties but, in some cases, it can also make obtaining loans more difficult. The IRS also notes that it may create a substitute return itself for those who haven't filed. But before you think this means less work for you in preparing your taxes, when the IRS writes up the return, making sure you get all your exemptions and deductions is not exactly top priority.

Refusing to cooperate can also lead to the beginning of the collection process, including levies on wages and notice of a tax lien.

To avoid this issue, you may want to consider setting aside money, especially if your employer isn't withholding enough. And if you already know you can't pay your taxes, still make sure to file your return and get in contact with the IRS.

Bad debts
As many Americans struggle with debt, it's important to know which debts are the most harmful. With all their fees, penalties, and high interest rates, payday loans, credit card debts, and overdue taxes are three types of debt to avoid whenever possible.

But for the times when there is a cash shortfall, be sure to consider alternatives. Contact a local bank or credit union or even friends and family. And most importantly, don't just push the debt off until tomorrow unless you want to pay even more.

Take advantage of this little-known tax "loophole"
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 24, 2014, at 5:06 PM, segarolow4 wrote:

    WOW. This person must be very very rich.. Are living in dream land.... I bet it is number 2..

  • Report this Comment On August 24, 2014, at 7:15 PM, InitialG wrote:

    The second part of "Credit card debt" makes no sense. You aren't earning 30% more per year by not having cc debt no matter how you look at it. The money is already earned, you are just keeping it in your pocket.

    Warren Buffet on the other hand IS increasing his money by 20% on his investments.

    There's a different between keeping the quarter in your pocket by not spending it versus finding a quarter and adding it to the quarter you already have.

  • Report this Comment On August 28, 2014, at 3:12 PM, superchicken wrote:

    Why would they have to be rich to not have credit card debt or payday loans or owe the IRS money? This is just common sense. If you can't afford it or can't save the money to buy it, don't put it on your credit card.

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Alexander MacLennan

Alexander MacLennan is a Fool contributor covering Industrials, Airlines, and Financial companies. He is always ready for a good growth or turnaround story and tries to find them before the market does.

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