Debt is a huge drain on many Americans. In fact, American household debt hit a record $13.21 trillion in 2018. But, believe it or not, not all debt is bad. Some forms of debt can be classified as “good debt” -- or debt that provides us with advantages -- as long as we don’t abuse it.
In short, good debt is a debt that is acquired to enhance your ability to pay in the future. Some good examples may include (but do not always include) student loans, a business loan, or a property that is likely to gain value.
“Bad debt”, can be classified as anything that does not increase in value or debt that was acquired for a depreciating asset. Determining whether or not a debt is good or bad sometimes depends on an individual’s financial situation. Bad debt is often the result of things we do or get that satisfy a fleeting emotion like the desire to look good or gain approval from others, often purchased with credit.
Because not all debt is bad, we can pause at this time of year to be thankful for debt that can actually assist us in moving forward and recognize the good things that have resulted from using credit and debt in helpful ways.
1. It allows us to get an education: A college education gives us a leg up. And, without student loans, a degree would be unattainable for most of us. But you don’t need to go to the most expensive university to get that solid education.
Instead, take a hard look at the financial aid offers and total costs at each of the schools that you’re considering. Don’t discount the state college down the street, where the average tuition is about $9,500 per year compared to $32,000 for the average four-year private school. Community College programs are typically even less of a tuition investment. You’ll also need to keep in mind how much money you’ll earn once you graduate from college.
FinAid recommends that student loan payments equal no more than 10 percent to 15 percent of your expected income. The website offers a calculator where students can select their field of study and determine how much debt they’ll be able to comfortably afford once they’re working.
2. It gives us a roof over our heads: Home mortgages have allowed many of us to check off this big ticket item from the American Dream wishlist. But, just because a loan officer has approved you for a $300,000 house doesn’t mean you should buy a $300,000 house.
Monthly house payments should generally be no more than 28 percent of your income before taxes. And, it’s always best to spend less than you can afford so you have more money to pay off other debt, save for retirement or take that dream vacation. When shopping for a house, look for a home you love, but in a price range that’s far less than the most that you can afford.
3. It gets us to work: For many in the United States, especially in areas with no public transit, owning a vehicle is a must. While a vehicle loan is not typically considered a helpful debt, it’s a reality that for most of us, paying cash for a car is out of reach. The average price of a new car is about $33,500, according to the Kelley Blue Book. It’s $16,800 for a used one, according to Edmonds.com. Thankfully, we have car loans, and if they help you get and keep a solid income, it’s worth it to take one on. Still, it’s important to keep the amount you borrow low. A general rule of thumb: Your car payment should be no more than 15 percent of your take home pay. And it’s always better if it’s less.
4. It helps us in emergencies: Imagine your house full of guests for Thanksgiving and your furnace shuts down. Thanks to credit cards, you can easily pay for a replacement. While credit card debt isn’t a debt you should aim for, it’s ok to use our credit cards occasionally to help us out in an emergency. What’s far better, however, is to use emergency debt as a way to move you towards the realization that you need healthy saving habits moving foward. Make it a goal to built up a solid emergency fund. With an emergency fund, you’ll have more than enough money to completely pay off that credit card bill when it comes due.
Debt isn’t always bad. And it definitely doesn’t have to be a drag as long as you borrow only what you can afford -- and pay it off as quickly as you can. Debt can be useful and can assist you in building a strong credit profile. The key is knowing the right kind and amount of debt you can manage responsibly so you can be in control of your debt instead of your debt controlling you.
If you are experiencing financial difficulty and are looking for a solution, non-profit credit counseling can help you make sense of all your options. Contact us today for a free financial assessment with one of our certified credit counselors.
Consumer Education Services, Inc. (CESI) is a non-profit service provider of comprehensive personal financial education and solutions for all life stages and for all of life’s milestones. Our goal is enhanced economic security for everyone we serve.
CESI is NOT A LOAN COMPANY