With only a month left in the decade and resolutions around the corner, now seems like the perfect time to explore a pervasive problem—personal debt. Household debt rose to a record high this year. As of the third quarter of 2019, the total U.S. household debt hit $13.95 trillion. That’s $1.3 trillion above its peak in 2008.
Debt is a broad subject and while the word may cause many to sweat, not all debt is bad. Without debt large purchases like homes would be unrealistic for many. So if not all debt is bad, is there good debt? And if yes, what is the difference?
In this first part in an ongoing series about personal debt, we’re going to look at the difference between good and bad debt.
Debt is a normal part of most American’s lives. Free and clear of all personal debt isn’t practical for most of us and as such, some debt is defined as good. But this good really just means “not damaging” to your financial health.
In a broad sense, good debt is any personal debt that helps you generate income and/or increases your net worth. This means that often, but not always, educational debts, real estate, and small business ownership fall into this category.
An education can help you increase your marketability in job hunts, and help you land larger salaries. This adds to your overall perceived value to the workforce. However, this good type of personal debt can quickly turn bad. For example, if you get a degree in Puppetry, the cost of your education will probably outweigh your potential earnings. The average college graduate leaves school with about $30,000 in debt and every day three thousand borrowers go into default.
Additionally, any specialty programs might not help you find a job. In some cases, these highly specific career paths require you to accumulate more educational debt as you continue to advance degrees—like masters and doctorates. Similarly, if you attend an expensive, out of state school for your useful business degree, the cost of your loan could quickly turn into bad debt.
Real estate, in general, adds to your net worth. However, if you buy a duplex and lose your renters, can you still afford the mortgage? If not, your good debt could curdle like bad milk. The same can be said for owning a business. If your costs outstrip your income, and the bills go unpaid, what is the business adding to your net worth? But in most cases, owning a business, real estate, and education are examples of good debt.
If good debt adds to your net worth or generates income, bad debt is anything that doesn’t. Bad debt also applies to purchases made with borrowed money that depreciate. This means cars, credit cards, and payday loans all fall into the bad debt category.
Cars can be a fairly benign form of bad personal debt. Though they lose value the moment they leave the lot, you are using them as they depreciate. Most of us do not have the luxury of working from home, which means you need transportation. For many, paying cash for a vehicle isn’t practical, or necessary. If you get a low interest rate, buy within your means, and pay your loan off quickly auto debt is usually negligible. But if you buy a car you can’t afford or have a higher interest rate, this benign kind of personal debt can turn malignant to your overall financial health.
Credit cards are one of the worst forms of bad debt. They are considered “revolving” debt, meaning they are meant to be paid off each month. But, the average household carries over eight thousand dollars in credit card debt. Card companies set up their payment schedules to maximize costs to you and maximize the interest you pay them.
Many credit card companies offer rewards for using their card. But, if you don’t pay off the debt the interest is often more than the reward’s monetary value. When considering a reward card, make sure to weigh the risk versus the reward to see if it’s really worth it.
Payday loans are always a bad form of personal debt, but they can move beyond simple bad to something poisonous in your finances. Payday loans often come with insane interest rates as high as 300 percent.
There are also a few types of personal debt that are a bit murky. Consolidation loans is one of them. These can be immensely valuable tools to lower interest rates, but the cash must be used to pay down debts.
Medical debt is another grey area. Medical personal debt is largely out of your control and often doesn’t have interest, but it can impact your ability to rent or purchase a home. In fact, 38 percent of people who owe money for health care have been turned down for mortgages or home rentals. Medical debt is more commonly the culprit for these denials than credit card or student loan debt.
Ultimately, when you look at personal debt, the issue is spending. While there are some types of debt that you cannot avoid—medical for instance—the bulk of both good and bad debt fall on personal choices.
Next week we’ll take a closer look at specific spending and saving habits and how they are impacting the personal debt problem.