Debt – The Good, The Bad, and The Ugly

September 28th, 2012 Mark Sandvig

Debt is one of those subjects most people don’t want to talk about…it can be embarrassing and frustrating. The truth is, understanding different kinds of debt is one of the most critical elements in financial success and security.

Today, many Americans are in more debt than they planned, or ever expected. The reason is simple: it has been easier than ever for today’s generations to borrow and spend money. That’s why it’s so important to know what types of debt can be good for you and your future – and what kinds you should try to avoid.

The good

A lot of people believe “there is no good debt.” True, it’s nice not having any debt at all. But realistically, in today’s world, almost everyone faces situations where they need to borrow money.

So how do you determine if it’s good debt? A good way to start is to ask yourself “Am I borrowing for…

…something I truly need?”

…something that appreciates in value?”

…something that will pay off in the future?”

If you answer yes to any of those questions, chances are the debt you take on can be considered good. Here are some examples:

1. Home mortgage

Buying a home can add a lot of debt, but it can be very good. It gives you a place to live and raise your family, can offer tax savings, and can build value that becomes a source of retirement income. The important thing is to make sure you get a good, low loan rate, and that you’re not borrowing more than the value of the home.

2. Education

Borrowing for college or technical education isn’t just debt – it’s an investment. It’s often better to borrow money for higher education because people with college degrees tend to earn more during their lifetime than people without a degree.

3. Medical care

What is a life worth? Anything and any amount it takes. That’s the bottom line. If you need to borrow money to pay for medical expenses, don’t feel bad. Staying healthy and living a good life is worth it.

4. Vehicles

Cars are expensive these days. Most people can’t afford to pay for a car with cash. But having a car may also be critical to your job. If you don’t have public transportation available, you need a vehicle to get to and from work. The key to keeping it “good debt” is to get the lowest interest rate possible on the loan. It’s also wise to consider a used car instead of a new one, which can save you a lot.

5. New business

Starting a business can have a lot of risk, but it’s also one of the greatest financial opportunities. If you have a good plan for opening a successful company, then borrowing money to help start it makes sense, because it can definitely pay off.

The bad

1. Credit cards maxed out

Using a credit card can be good debt – if you pay off the balance monthly, or keep the balance low. But, credit cards are bad debt when you max out your credit limit, pay only the minimum monthly payment, and get hit with high interest rates. It can cost you huge amounts of interest over many, many years.

2. Charging daily expenses

Borrowing money to pay for gas, groceries, clothes, movies and other daily expenses can really mess up your financial future. The main reason is it allows you to not follow a budget, and easily spend more money than you earn. One of the keys to financial success is to always pay your daily expenses with money you have on hand. Don’t take your credit card to the grocery store!

3. Luxury items

When it comes to vacations, RV vehicles, jewelry and other luxury items, don’t buy them if you don’t have the money. They’re “wants,” not “needs.” Pushing yourself deep into debt buying things you don’t need is not a smart financial move. Better to save your money until you can actually afford the luxury item.

The ugly

1. Payday Loans

Payday loans can be one of the most horrendous debts of all. The interest rates are ridiculously high, and often wipe out your next paycheck, so you have to borrow more. A small loan from a payday loan company can actually cost you a small fortune.

2. Raiding your 401K

The whole idea of a 401K is to put away money for your retirement. When you borrow from your 401K, you not only have to make payments, but you also reduce the potential for your 401K to grow. The end result can be more debt now, less money for your retirement.

3. Loans from relatives

If you have rich relatives with lots of money who are happy to make loans to you, then it can be good debt. But often, borrowing from relatives (especially if you don’t pay them back) can cause a lot more than just financial problems – it can create anger, frustration, and even ruin relationships.

The bottom line? In today’s world, many of us need to borrow money for different things in our lives. The key is to make sure those things you borrow money for are truly important, and will actually lead you to a better financial position. It’s also important to borrow at low rates, keep your total debt under 36% of your gross income, and make sure you’re comfortable making each and every payment. Use debt to build your future, not ruin it.

About the author

Mark Sandvig is Mortgage Banking Officer at MidWestOne Bank. NMLS number: 641615

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