Most of us aim to be debt free. That extra money can go towards savings, pensions, even a vacation. Though, paying off debt is increasingly an impossible goal for many American households. Is this something we should be concerned about? Provided we make sensible financial decisions, debt can be a positive aspect of our financial profile.
In this blog, we will look at why debt - if dealt with in the right way - can be good for you, your future, and the economy.
Good Debt : The Debt that Increases Your Income (Eventually)
Good debt can help you over the long term by increasing your income in the future. An example of this is borrowing money to start your own business. You are taking on debt that will enhance your future income. Taking out a mortgage is another example of good debt. Over time, your property should gain value, so when you sell your house you will be able to pay off the remaining debt and have money left over.
Here are some examples of good debt:
Mortgage on your own home
Mortgage on rental property
Arguably, an auto loan could be considered to be a bad debt. Unlike a house, it will depreciate in value, so when you sell it, it will be worth far less than you originally paid. But, the car will probably allow you to travel to your job, meaning it’s an important factor in your earning potential. The key is to purchase a car that you can afford. Like all forms of credit, this means researching the best interest rates available and choosing the one that is most appropriate for your personal circumstances.
Bad Debt: The Debt that Will Not ‘Pay for Itself’ Over Time
Conversely, bad debt is debt that will not enhance your future income. It will drain your wealth and offer no return in the future. Bad debts tend to be unaffordable, with no realistic repayment plan. A luxury holiday that leaves you unable to meet other financial commitments is an example of bad debt.
If you need to borrow money to pay other loans, this is an indication that you are caught in a cycle of bad debt. Payday loans tend to be examples of this. They have high interest rates, leaving borrowers with no realistic prospect of paying them back.
How to avoid getting into financial difficulties as a result of bad debt:
Shop around for the best deal
Spend time working out your monthly budget so you know you can comfortably meet repayments - don’t assume you can!
Ensure you can afford potential interest rate increases
Never be pressured into taking on debt
Make sure you clearly understand the terms and conditions
Know what the risks are in the event that you fail to meet payments
Should I Avoid Debt?
Providing you use debt - good and bad - wisely, you can reap the financial rewards. Let’s look at the student loan. For most students, a loan is the only way to pay for college; is it worth it? Students today graduate with an average of more than $35,000 in student loan debt. But, those with a Bachelor’s degree are significantly more likely to secure a well-paid job, a promotion, and health insurance. College graduates will earn, on average, $20,000 a year more than those who finished their education at high school level. Over a 40-year working life, a college graduate will earn approximately $800,000 more.
If you are a small business owner, taking out a loan can make the difference between your business thriving in those difficult early days, and failing. Growing your business using cash can be a slow process; a loan can speed up the process. Of course, this is not without risk - you should always discuss the implications of any major decision with your financial advisor.
You might be surprised to read that bad debt is not always to be avoided. For example, if you pay off your credit card balance in full every month, you will build up a good credit score. This is essential when you are being assessed for credit risk for a mortgage. You might also get perks such as discounts on airline tickets and shopping bills. Again, research the perks offered by each of the lenders - if you spend most of your income on food, look into credit cards that will help you make regular savings.
If you follow the advice shared above every time you consider taking out bad debt, you will not fall into financial difficulties. Being aware of and honest about your present financial outlook is key when you are drawing up a budget. If there is any doubt that you might be able to pay back the debt on time while meeting financial commitments, then do not take on the debt.
Debt in moderation can be good for you and the economy. It enables us to spend more and brings about an increase in income levels in the economy. The key to making debt work for you (rather than the lender) is to be sure to not overextend yourself. You must be certain you can meet all your financial commitments in full every month. If you have done the calculations and know you can afford to borrow the money to buy a coffee, a new toy for the kids, or to grow your business, and then pay it back in full - along with your other financial commitments - then go for it!
If you find yourself in financial difficulties, please seek expert advice as soon as possible. There is a team at Cabanillas Law who have had years of experience helping people just like you. You can contact us now to book an online appointment, or phone 1-800-LA FIRMA.