All debt is debt, right? We take possession of what we want now and eventually pay off the debt further down the road. Consumer debts are divided into two distinct types: good debt and bad debt. But “good debt and bad debt” is an oversimplification. We don’t always fully assess all the components of debts.
The difference between “good debt and bad debt” is more nuanced.
For example, certain “good debts” can tilt in a person’s favor and benefit their needs if the debt is managed responsibly, while “bad debt” can be any debt you’re unable to pay off.
What’s important is to do your best to honor debts unless your finances crash and burn.
“For many of us taking on debt( in many different forms) it’s necessary for us to move forward in life,” Michael Micheletti, Senior Director of Corporate Communications at Freedomfinancialnetwork.com, told Newsblaze.
“It is nearly impossible in today’s environment to buy a home without taking on a mortgage,” Micheletti explains to Newsblaze.
Michelletti continued …
“Taking on any debt must be weighed carefully and taken on only with a clear plan for repayment.” “And no amount of debt is healthy if a consumer doesn’t have enough cash flow to cover all living expenses, debt repayment and savings, particularly emergency fund savings.”
So, the big question rest upon if the average American consumer knows whether they should or shouldn’t pay for a bachelor’s degree that may land them a job with a salary that’s way less than what the loans cost to finance the degree, while simultaneously hoping to finance a home with an affordable mortgage that may increase in value beyond the original sales price, are no guarantee in today’s topsy-turvy economy.
According to Carrie Schwab-Pomerantz, a financial advisor and President of Charles Schwab Foundation, the rule of thumb is that, “You shouldn’t borrow more (in total) than you expect to earn in your first year on the job.”
Good debt and bad debt is a recurring topic that is important to discuss to help consumers understand the new rules of the debt game. Although student loans and mortgages can be successfully used to build wealth or increase income, in many instances, those things aren’t always the case.
“Good debt,” when used in a budgetary, responsible way, depends on various factors.
With that said, let’s dive into the debt world and show consumers some ways to better manage their debts in 2021. Think of 2021 as a fresh start to work towards solving your money problems, saving money and increasing your savings.
One of the most irritable things that keep people up at night besides sickness, a restless body or a bad dream is the “Big D” called debt.
According to a 2017 survey by PricewaterhouseCoopers, approximately 53% of workers stressed over finances.
With these astounding numbers, debt has incurred a “bad name,” contributing to a major cause of stress for individuals. Still, though, here’s news on the brighter side: not all debts should keep people up late at night in worried mode, and, at some point, a good debt should allow people to rest better, and inspire them to hope for a financially secure future.
To repeat the words of the Nation’s Declaration of Independence; all debts aren’t created equal – from credit cards to mortgages and student loans – there are good and bad debts.
Bad debt is spending on an item that decreases in value once you purchase it. Now we’re talking about millions of consumers because of much of life’s basic necessities like jewelry, expensive shoes, clothes, vehicles, iPhones and the large flat screen television that you need to watch your favorite sports.
Anyone who cannot pay cash for the items listed above should consider purchasing bargain price clothes or even consider buying a used low-mileage vehicle and a smaller television. The more costly items can easily translate into bad debts, especially if you rent the biggest screen television from Aaron’s rental etc. Interest rates are exceedingly high at rental companies.
Good debts often refer to debt incurred on things that offer a return on an investment like student loan, small business loan or a mortgage etc. Good debt can boost a person’s income or net worth in the future. Investing in your child’s education can be a good debt providing everything goes well.
“Good debt can improve your long-term financial situation,” says Leona Edwards in an article published by Credit Karma.
Edwards is a CFP and financial planner at Snow Creek Wealth Management in Nashville, Tennessee.
Debt is a necessity for many Americans without much wealth but determined to pursue a college degree to earn a good living to take care of themselves. Yet, what many people have now realized is that not all college degree programs match up with the nation’s economic conditions.
Student loan debt reached an all-time high of $1.54 trillion in 2020. Financial expert Carrie Schwab-Pomerantz insists that if a student is going to earn $50,000 right out of college, you shouldn’t have more than $50,000 in student loans total.
“Good debt is bad debt when you’re drowning in it,” Schwab-Pomerantz, said. Schwab-Pomerantz said the student loan amount is premised on the notion that with yearly salary increases, a person should be able to maintain the interest in their debt and pay off the loan within the standard 10-year repayment period. (Read Debt Forgiveness: See if you qualify for student loan forgiveness):
Freedom Financial Network Director Michael Micheletti, said, “Students can be smart not just about getting into college, but minimizing the amount borrowed by taking several steps.”
Here are the steps:
- Check out all possibilities for scholarships, including parents, employers, churches, nonprofit organizations, and credit unions. Many offer scholarships that are not all based on academics or athletics.
- Look into tuition-free schools like the Webb Institute in Glen Cove, New York; the Cooper Union for the Advancement of Science and Art in New York, and Franklin W. Olin College of Engineering in Needham, Massachusetts, offer half-tuition scholarships to every student.
- The Work Colleges Consortium lists schools that offer free or reduced tuition in exchange for student work.
- Consider attending a local school for the first one or two years of college. Community college tuition can cost around $3,500 per year, versus about $35,000 for out of state students attending a public university.
Purchasing a Mortgage
Can anyone think of a debt more valuable than a mortgage? We need a roof over our heads somewhere on this planet, a place to live that gains value each year. Housing prices increased an average of 6.4 % a year from 1968 to 2004. Unfortunately, the housing “bubble” started to burst in 2006/7, ushering in the twenty-first century recession.
Before Barack Obama left the White House in 2017, the housing market mostly recovered with the median home value in the U.S. hitting $196,500 in March of 2017, according to Zillow.com. Calculating the numbers equals 6.8 % increase within a year and climbed an upward trend, beginning in 2012.
What does this mean in real money terms?
For example, let’s say you buy a home for $235,000 – and it appreciates 3% a year, then your home’s value is worth $485,000 – when your 30-year mortgage is paid off. If your home appreciates at 4% a year, the initial $235,000 investment equals to $649,000.
Taken together, that increase in numbers is a very good debt to have. However, as the subprime mortgage crisis has taught us, house prices don’t always rise indefinitely.
During the subprime mortgage crisis, millions of borrowers lost their homes to foreclosure when home prices dropped and ARM( Adjustable-rate Mortgage) loan payments adjusted upwards.
What is an Adjustable-rate Mortgage?
Adjustable-rate Mortgage is a mortgage where the rate applied to the outstanding balance varies throughout the life of a loan.
Plastic can literally destroy your credit score and wreak havoc on remaining finances you may have access to. And, to add more woes, interest rates on credit cards are the exterminator. And the interest rates can be painfully confusing. Credit card companies love it that way, too. If consumers knew the amount they were paying to use a Visa or Mastercard, they’d howl in protest!
Remember the discussion about the Flat Screen television? What if you found a TV for $1200.00, and you purchased the TV with your credit card at 18.9 % interest rate. And, further, if you paid $60 per month, it’ll take 63 months to pay off – at a cost of $1,676.98. That’s not a good debt. The high interest rate on the card you’re using to buy the TV is ripping holes in your pockets.
According to a Nerdwallet survey in 2016, average households with credit card debt carry an approximate balance of $15,733 – which clearly indicates how people surpassed the recommended 30% credit utilization ratio.
To put it another way: if you’re using more than 30% of available credit, your credit score will eventually suffer which means the lenders will charge higher interest rates when you apply for a loan or new credit.
Car loans can be good or bad. A car loan is good if the loan is paid off, thus the payoff can increase your credit score. Default on a car loan goes on your credit score as a negative. Unless a person buys a 1939 Cadillac, a 1965 Shelby Mustang or another in-demand antique vehicle, cars are worth less immediately after leaving a lot. Vehicle loan interest rates are only higher when a person has a spotty credit history.
Overall, most consumers wind up paying higher interest rates on new vehicles because they want a name-brand car with a shiny color. If your credit history isn’t too good, why not purchase an up-to-date used car, pay it off, increase your credit score, and maybe then buy a Mercedes or a Cadillac SUV.
Payday loans are blood-sucking sharks!
Credit cards can cause a deep pinch on finances but Payday loans are 5-to-10 times worse. Payday loans are attractive outlets because, unlike banks and credit unions, Payday loans do not require borrowers to verify their ability to repay loans prior to releasing the funds.
Trying to wrestle with “hungry sharks” in the Payday Loan and Check Cashing industry is no easy task due to sky-rocketing interest rates. A person can borrow short-term cash to help them navigate through an emergency hardship. To get a Payday loan the borrower must post-date a check because the representatives depend on you to pay off the balance once you get paid during your next pay period. Payday loans are quick to process. But the finance charges can blow your socks off. Payday lenders generally charge interest rates of $15-$20 for every $100 borrowed.
Calculated at an annual percentage rate (APR), the same is used for credit cards. When a borrower defaults on the loan the interest rises as high as the sky. For example, Keith Elliot, of Kansas City Missouri, borrowed $500 (five times) from a Payday lender.
Guess what the interest cost him? A whopping $50,000.
Worse, in some states, Payday lenders have had people arrested for failing to pay off loans. Be very careful when dealing with Payday loans and avoid them as much as possible.
Too Much Debt?
How do you know if you have too much debt?
A key clue is when your extra source of income is hustling scrap metal. Scrap metal is just an analogy to show how too much debt can drain our financial resources. To simplify the meaning, it is important to assess your debt-to-income ratio. For example, calculate your monthly debt payments, divide the debts with your monthly gross income to get your debt-to-income ratio.
So, let’s say you have a $1,200 monthly mortgage, $450 car payment, $300 per month for credit cards, then your monthly debt is $1,950.00. And, to add, there’s probably cell phone bill, vehicle insurance and utility bills to throw into the salad bowl.
Therefore, if a person’s monthly income averages $3000, that means the debt-to-income ratio equals to 50%.
And yet, here’s the kicker.
A consumer that has a 43% debt-to-income ratio, the 43% ratio automatically triggers a red flag to a potential lender that you’re trying to obtain a loan from. Bottom line: the 43% debt-to-income ratio isn’t good, although people need basic necessities.
In life, things aren’t always foolproof. But if we take time to educate ourselves about our finances and debts we gain confidence to take charge, and make better informed decisions of how we spend money, pay off debts, and save money for our future.
USA Today published an article titled 21 ways to reduce debt and build an emergency fund in 2021: https://www.usatoday.com/story/money/personalfinance/2020/12/17/personal-finance-2021-how-build-emergency-fund-reduce-debt/3910425001/
Don’t pay excessive fees to consolidate your debts or pay for debt counseling. CNBC news published a list of free resources to help people learn the mechanics of managing debt and finances. https://www.cnbc.com/2021/01/13/the-best-free-resources-to-help-you-learn-how-to-manage-your-money.html
If somehow you feel you have a serious spending problem that creates unnecessary debts, seek help from Debtors Anonymous, a debt-help group that operates similar to Alcoholics Anonymous. https://www.thebalance.com/get-debt-help-through-debtors-anonymous-960611