Debt is part of the American way of life. Although credit card debt levels actually fell by $76 billion in the second quarter of 2021 — the largest quarterly decline in history — overall debt levels continued to rise, a trend that is now long-standing.
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According to Experian, consumer debt levels increased by 5.4% between 2020 and 2021, to a total of $15.31 trillion. A CNBC report breaks that down into a total debt of more than $155,000 per American family. This includes both “bad debt”, such as credit card debt, and so-called “good debt”, such as home mortgages. But, are these age-old classifications still valid? And how much debt is too high to reach a life milestone?
Here’s an overview of several popular types of debt and what experts think of their merit.
Residential mortgages are the quintessential type of “good debt” and, for the most part, experts agree that a residential mortgage does not harm your financial situation. For starters, you can get a tax deduction for the mortgage interest you pay on your primary residence, and your loan is also backed by an asset that is likely to appreciate over time.
According to finance professional Stanley Poorman, “How a loan is secured determines whether it is good or bad. A mortgage is secured by an asset — your home — that gives it an advantage.
Of course, just like a bad investment, a bad mortgage with a high interest rate and a high loan-to-value ratio is much riskier, and any loans you can’t afford, even home mortgages, are ” bad debts “. But overall, a mortgage can actually help you build wealth over time or, at the very least, give you a home of your own.
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Student loan debt
Student loan debt has always been classified as “good debt” because it is an investment in yourself that can generate long-term wealth. However, the size of student loans has gotten so out of control that there is now a national debate about the value of student debt.
According to Credible, average student loan debt is approaching $40,000, and 2.6 million borrowers have debt over $100,000. It can take years, even decades, to pay that money back, even with a good job.
While it’s true that those with a college degree earn almost 50% more than those with a high school diploma, according to data from EPI’s State of Working America Data Library, one of the largest great risks can be those who start university and cannot finish it. . As Elise Gould, senior economist at the Economic Policy Institute, told CNBC Select, “About a third of people went to college, but they couldn’t complete their education because of the cost.”
It would leave you in the position of going into debt without the financial benefits of a degree to help pay it off.
Credit card debt
Credit card debt is universally decried by financial experts, but Americans still had an average balance of over $5,200 at the end of 2021 according to Experian. There aren’t many redeeming qualities for credit card debt, which usually comes with double-digit interest rates and the inability to forgive any interest.
According to Kim Cole, community engagement manager at the National nonprofit credit counseling agency Navicore Solutions. Be careful, however, even this strategy requires you to have the money to pay off the debt at the end of the promotional period.
An auto loan is another choice that falls in a bit of a gray area. Many loans can be obtained at interest rates as low as 0%, which can be a great use of your money. But if it encourages you to take out a bigger loan than you can afford, it may be a bad choice.
Many car loans are also predatory, with extremely long maturities and high interest rates. And although you buy a property with an auto loan, it is a property that depreciates and loses value over time.
The reality, however, is that most Americans cannot afford to buy a car with cash. So if you need to take out a car loan, always shop around to get the best terms possible.
Personal loans are often taken out for a specific purpose, such as a home renovation or a one-time event such as a wedding. This puts many personal loans in a kind of gray area.
A home renovation, for example, can add value to your home, but unless you sell it immediately, you won’t receive a return of principal to pay off that loan. A special event like a wedding, on the other hand, is simply an expense. A personal loan probably has better interest rates than a credit card, so at least it’s a step in the right direction, but it’s also difficult to start a new married life while taking on a heavy debt load. .
Perhaps the best use of a personal loan is to pay off high interest credit card debt. According to Northwestern Mutual financial adviser Ashley Russo, “With a lower interest rate, you have the ability to pay more principal than interest, allowing you to pay off debt faster.”
Can Americans’ reliance on debt ever be contained?
The reasons why Americans continue to go into debt, to a large extent, are inherent in the system. For starters, there is a lack of quality basic financial education taught in schools. Even for those with basic financial skills, American society is structured around getting loans to buy a car, a mortgage to buy a house, and using credit cards for everyday purchases. .
Add to that reports that more than half of Americans can’t afford a $1,000 emergency out of their savings, and it’s likely that most Americans will find themselves in some sort of debt. The key is to use debt for assets whenever possible, find the lowest interest rates and most favorable terms, and never take on debt that exceeds your ability to repay it. This is how you can truly determine whether your debt is “good” or “bad”.
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This article originally appeared on GOBankingRates.com: Good Debt Vs Bad Debt: Is It Worth Going Into Debt To Reach A Life Milestone?