Good Debt vs. Bad Debt: Is It Worth It To Take on Debt To Reach a Life Milestone?
Debt is part of the American way of life. Overall debt levels continued to rise, a pattern that is now long-standing. A CNBC report breaks that down to total debt of over $155,000 per American family. This includes both “bad debt,” such as credit card debt, and so-called “good debt,” like home mortgages.
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But, are these age-old classifications still valid? And how much debt is too much when taken on to reach a life milestone? Here’s a look at several popular types of debt, and what experts feel about their merit.
Home Mortgages
Home mortgages are the quintessential type of “good debt,” and for the most part, experts agree that a home mortgage isn’t detrimental to your financial situation. For starters, you can take a tax deduction for the mortgage interest you pay on your primary residence, and your loan is also backed by an asset that is likely to appreciate over time.
According to financial professional Stanley Poorman, “How a loan is secured determines whether it’s good or bad. A mortgage is secured by an asset — your house — which gives it an advantage.”
Of course, just like a bad investment, a bad mortgage with a high interest rate and a high loan-to-value amount is much riskier, and all loans that you can’t afford, even home mortgages, are “bad debt.” But by and large, a mortgage can actually help you build your wealth over time — or at the very least give you a home of your own.
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Student Loan Debt
Student loan debt has always been classified as “good debt,” as it’s an investment in yourself that can generate long-term wealth. However, the size of student loans have gotten so out of hand that there’s now a national discussion about the value of student debt.
According to Credible, the average student loan debt is approaching $40,000, and 2.6 million borrowers have debts larger than $100,000. It can take years, if not decades, to pay that money back, even with a good job.
While it’s true that those with college degrees earn nearly 50% more than those with a high school diploma, according to data from EPI’s State of Working America Data Library, one of the biggest risks may be those who start college and can’t finish it. As Elise Gould, senior economist at the Economic Policy Institute, told CNBC Select, “About a third of people have attended some college, but they couldn’t finish the degree because of the cost.”
This would leave you in the position of taking on debt without the financial benefits of a degree to help you pay it off.
Credit Card Debt
Credit card debt is universally maligned by financial experts. There aren’t many redeeming qualities to credit card debt, which typically comes with double-digit interest rates and the inability to write off any interest.
There is one potential good use of credit card debt, and that is if you have a high credit score and can avail of a 0% balance transfer offer to pay off higher-rate debt, according to Kim Cole, community engagement manager with the national non-profit credit counseling agency Navicore Solutions. Beware, though — even this strategy requires you to have the money to pay off the debt at the end of the promotional period.
Auto Loans
An auto loan is another choice that falls into a bit of a gray area. Many loans can be had for interest rates as low as 0%, which can be a great use of your money. But if that encourages you to take out a larger loan than you can afford, it can be a bad choice.
Many auto loans are also predatory, with exceedingly long maturities and high interest rates. And although you’re buying an asset with an auto loan, it is a depreciating asset that loses value over time.
The reality, however, is that most Americans can’t afford to buy a car with cash. So, if you have to take out a car loan, always shop around to get the best terms possible.
Personal Loans
Personal loans are often taken out for a specific purpose, such as a home renovation or a one-off event like a wedding. This puts many personal loans into something of a gray area.
A home renovation, for example, can add value to your home, but unless you immediately sell it, you’re not going to receive a return of capital to pay that loan back. A special event like a wedding, on the other hand, is simply an expense. A personal loan likely has better interest rates than a credit card, so at least that’s a step in the right direction, but it’s also hard to start a new wedded life while shouldering a heavy debt burden.
Perhaps the best use for a personal loan is to retire high-interest credit card debt. According to Northwestern Mutual financial advisor Ashley Russo, “With a lower interest rate, you have the ability to pay down more principal than interest, which allows you to pay down debt quicker.”
Can Americans’ Reliance on Debt Ever Be Contained?
The reasons why Americans continue to take on large amounts of debt, to a large degree, are inherent in the system. For starters, there’s a lack of quality basic financial education taught in schools. Even for those who have basic financial skills, American society is structured around getting loans to buy a car, getting mortgages to buy a home and using credit cards for daily purchases.
Add in reports that more than half of Americans can’t pay for a $1,000 emergency out of their savings, and it’s likely that most Americans will end up with some kind of debt. The key is to use debt for assets wherever possible, find the lowest interest rates and most favorable terms, and never take on debt that overwhelms your ability to repay it. That’s how you can truly determine if your debt is “good” or “bad.”
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This article originally appeared on GOBankingRates.com: Good Debt vs. Bad Debt: Is It Worth It To Take on Debt To Reach a Life Milestone?
