For the majority of Americans, living a debt-free life is virtually impossible. Whether you’re paying credit card bills, endless amounts of student debt, or a mortgage, debt is just a part of part of life. Let’s face it, no one likes to owe money, but could it actually be useful in certain situations?
In all, Americans owe $11.4 trillion in debt. The average American carries more than $15,000 in credit card debt, more than $33,000 in student loan debt, and has a mortgage debt of around $156,000. For some things -- like paying for your education or a house -- it makes sense to borrow. But is there such a good thing as good debt?
Truthfully, owing money to someone or for something isn’t really ever a good thing. But unless you’re rolling in cash, chances are that you will have to take on some debt in your life. In some instances, debt can be beneficial to your bank account -- an important part of building wealth and managing your assets.
What is good debt?
Good debt creates value. It is an investment that will help you produce more wealth over time, even if your pocketbook initially takes a hit. Take a house, for instance. Unless you’re incredibly rich, chances are that you will have to take out a mortgage to pay for your home. Over time, that home is going to appreciate in value.
Bad debt is a bit of a misnomer because, as previously mentioned, all debt is bad in some respects. That said, bad debt will lose you money over time. It does not help you achieve something better for yourself. Payday loans are an example of bad debt. Many payday lenders have egregiously high interest rates that will actually make you lose more money in the long run.
There are some situations where good debt exists, though. The complicated thing about debt is that it’s good, depending on your individual circumstances. Here are common examples of what Americans might consider good debt, with information on how these “good examples” might be bad for you.
1. Student loans
With all the hoopla surrounding student debt and how it’s spiraling out of control, it’s easy to forget that research shows attending college can increase your long-term savings. Even though it’s harder for new graduates to find good jobs, the Pew Research Center has found that the median earnings of millennials who had at least a bachelor’s degree was $45,500, compared to just $30,000 for folks with some college experience and only $28,000 for high school graduates.
For many people, college is worth the high price because it pays off over time. But for every graduate who views their education as a positive investment, there are other graduates who walk away with a degree in their hand and big debt, not to mention bleak job prospects. Truthfully, there are many degrees that just won’t pay off. Is that a reason to not pursue a degree in, say, the humanities field? Not necessarily. But keep your future job prospects in mind when deciding whether to get into big debt for your chosen career path.
When it’s good: If you have a clear career path with the potential to earn a lot of money and need to finance your higher education with loans. Just be sure to borrow only what you need and continue to save.
When it’s bad: If your chosen career path will not generate significant income and you need to take out a bunch of loans to pay for your education. Consider attending a cheaper university, getting an associate’s degree, or going to a community college.
2. Buying a home
Owning your own home is still the American Dream for some folks, but chances are pretty high that you won’t be able to pay for your house in cash. Most real estate experts say that if you want to buy a home, you need at least a 20 percent down payment. The average sale price of a new home for June 2014 was $331,400, according to the U.S. Census. A 20 percent down payment on a home for that price would be $66,280 -- about $15,000 more than the average median American household income in 2012.
There’s really no right or wrong answer when it comes to the question of whether owning a home is worth the debt. Buying a home clearly has financial benefits -- it’s a valuable asset once it’s paid off and you get tax breaks too -- but there are some downsides as well. You’ll have to pay for repairs and maintenance and it’s not always easy to sell a property.
When it’s good: If your home mortgage will not significantly impact your financial situation. If renting is close to what you’d end up paying for a mortgage, taxes, and maintenance. Also, don't be afraid to wait and purchase at the right time -- 2014 is actually a great time to buy a home.
When it’s bad: If you have significant amounts of debt already and simply can’t afford to add a mortgage onto your pile of debt, or if renting is a better option for your lifestyle at the moment.
3. Purchasing a car
The average price of buying a new car in August 2014 is $31,252. Despite signs that America’s car culture is changing, folks still love their shiny vehicles (in particular, the Ford F-150, 2013’s best-selling vehicle). But can most Americans afford to purchase a new car?
Lots of people overspend on new cars. Whether you drive a lot, have an obsession with owning a luxurious vehicle as a status symbol, or are easily persuaded by those endless car commercials you see -- it’s likely that you have overpaid for your ride. If paying for the car’s sticker price, interest and insurance exceeds 10 percent of your household income, it’s likely that you can’t afford a new vehicle. The costs of buying a car don’t just end with the sticker price on the vehicle either. You have to keep in mind that you must pay for insurance and maintenance, too.
When it’s good: If you can get a good price on the right car and fund the purchase in the most affordable way. That means making at least a 20 percent down payment on the vehicle, financing it for no more than a handful of years and making sure that what you’ll end up paying doesn’t egregiously exceed your income. In addition, be sure you can afford the costs associated with owning a car like auto insurance and vehicle repair.
When it’s bad: If changing your lifestyle works better instead. Do you absolutely, 100 percent need the car? Can you rely on public transportation? Would it make more sense to move closer to work? Also, if it doesn’t fit your budget, don’t get an auto loan. You don’t want to get stuck paying off a loan for years and year. Oh, and have you thought about buying used?
When it’s worth going into debt
Generally, a good rule of thumb when you think about taking on debt is this: if you don’t have the money to pay for it, don’t purchase it. When it comes to large amounts of debt, a good question to ask yourself is: will this purchase appreciate in value? That’s when the debt might be worth it. Even if the purchase does have value, don’t just pile on debt because you can! It’s OK to wait, budget and save for a large purchase.