Good Debt vs. Bad Debt: What’s the Difference?
Whether it’s a mortgage, college loan or credit cards, most Americans have some form of debt. In fact, Americans’ household debt hit a new high in 2018: a whopping $13.29 trillion, according to a report by Federal Reserve Bank of New York’s Center for Microeconomic Data. The bottom line is, people are borrowing more. According to Northwestern Mutual’s 2018 Planning and Progress Study, average personal debt, excluding home mortgages, was more than $38,000, even higher than the previous year.
Although Americans spend a lot of time trying to get out of debt, data shows that they are, in fact, sinking further into it. Worrying about money leads to stress and anxiety, causing many Americans to feel insecure about their finances.
Despite the negative emotions debt can evoke, it’s important to understand that not all debt is bad. The distinction between “good debt” and “bad debt” is a critical one.
It may sound counterintuitive but there is such a thing as good debt. Generally, any debt that increases your net worth or will help you make more money is considered good debt.
Most people agree that getting a good education increases your earning potential in the future. While it is true that some degrees are more lucrative than others, college graduates typically earn more than Americans who only have a high school degree. Borrowing a large sum of money at a low rate and a lot of time to pay it back also carries another important benefit: you can build a good credit score. Although a student loan can come with its own set of stress-inducing problems, it is generally considered good debt.
Despite the massive financial losses stemming from the sub-prime mortgage crisis, a mortgage is still probably one of the best types of debt to have. In addition to some tax advantages, the opportunity to buy a home is an investment that mostly appreciates with time. Although home ownership is not for everyone, borrowing money to purchase a potentially appreciating asset is a smart financial move.
So what’s so bad about borrowing money? If the item you are buying depreciates over time, it is usually considered bad debt and, unfortunately, Americans have a lot of it.
Credit Card Debt
As of this year, Americans have the highest credit card debt in United States history. According to the Federal Reserve, in July 2018, American consumers have over one trillion dollars in revolving credit and the majority of it is credit card debt.
An individual’s average credit card balance is $6,354, according to Experian’s State of Credit survey. One glance at a credit card payoff calculator yields disheartening results: even with a low APR, it could take five years to pay off this debt and the total bill will be approximately $3,000 higher.
So how can you improve your financial health? By cutting credit card debt and using your cards that offer the greatest rewards.
After a home, a car is the second largest purchase an individual makes. Most financial experts agree, auto loans can be considered bad debt. First, cars start to depreciate the minute you drive them off the lot. Second, financing your car purchase can sometimes mean high interest rates. Although there is not much you can do about your car’s depreciation, there is a way to lower interest rates: good credit. A consumer’s auto loan rate is determined by their credit score: the higher one’s credit score, the lower their interest rate.
The bottom line for consumers is that all debt, even the good kind, carries with it financial implications. A good rule of thumb to achieve financial growth is to save money, make smart long-term investments, lower your monthly expenses, and reduce debt.
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