Overall, Americans owe a tremendous amount of debt – in total, more than $17 trillion of consumer debt. Much of what you hear about debt may emphasize that it’s not a good thing. Paying a large credit card bill every month, for example, may use up a large amount of your disposable income. This might impede your ability to save and invest.
But is being in debt really that bad? Frankly, the financial advisors at PAX Financial Group in San Antonio think that it depends. Whether debt is bad, good, or neutral depends very much on several factors. Those factors include how much debt you have, what you’ve incurred the debt for, what the interest rate is, and what your financial goals and outlook are.
Some Debt Builds Wealth
The fact is, some debt builds wealth. A mortgage, for example, can be genuinely the only way you have of purchasing a house. (It is for most Americans.) Yet a mortgage also gives you tangible benefits. It gives you shelter and a place to rest your head.
More importantly, from an investment perspective, a mortgage can help you build assets. Over time, the price of your house can rise. If it does, you are building household wealth. Of course, you only actually realize the increase in price if you sell your house. Nonetheless, a home whose price is climbing is an appreciating asset.
In addition, a fixed-rate mortgage protects you from steep increases in the cost of housing – which can occur if you continue to rent.
In addition, your mortgage interest is usually tax-deductible, as is property tax (up to a certain ceiling). Owning a home with a mortgage can thus reduce your taxes.
So a mortgage is a classic example of what we might call “good debt” – debt that helps you build wealth and also conveys other specific advantages.
Student loan debt can also be “good debt.” It doesn’t concretely build an asset, but it can build a better career and a stronger professional network than not going on to higher education. It therefore helps you build intangible assets.
In addition, interest rates on both mortgages and student loans are quite reasonable. Mortgage rates are currently above 7 percent, but interest rates on credit cards can run higher than 20 percent. The higher the interest rate, the more you’ll pay per month to service the debt.
What about car loans? You might be tempted to group car loans with mortgages. After all, a car loan helps you purchase an asset you may not be able to afford without it.
While both car loans and mortgages are secured by the asset they help purchase, car loans are not the same kind of “good debt” as mortgages are. A big reason is that cars don’t appreciate in value. They lose monetary value the minute you drive them off the lot.
So car loans are not good debt in the same way that mortgages are. But they aren’t bad debt, either. A car loan means, after all, that you have a car. That can be a valuable asset if you need a car to get to work.
Car loans are a classic example of “it depends.” If your car loan interest rates are reasonable, your monthly payments are affordable and you need a car, it can be good debt or neutral debt. But if you’re paying more than you can afford for a flashy set of wheels that you don’t need, it may not be a wise decision to take on the debt.
So How Do I Tell If Debt Is Good or Bad?
So we’ve just determined that some debt is good and some can be neutral or bad, depending on circumstances. How do you determine if debt is good or bad?
Remember, good debt helps you build wealth and provides positive benefits. Neutral debt is affordable and provides some positive benefits.
So what is bad debt? Well, there are several criteria to use to determine if debt is bad. First, payments on it may sap your disposable income while providing no benefits. Credit card debt may be like that. Credit card interest is high and most of what people buy on credit cards doesn’t build their wealth or provide any tax advantages.
Second, credit cards may carry very high interest rates, which is not prudent. Interest rates on personal loans are much lower, which is why obtaining a personal loan is one method of debt consolidation for people who need to reduce their debts.
The next factor depends on your circumstances. Your ability to meet your financial goals, save and invest – and even meet your basic monthly expenses — can be impacted if you have too much debt vis-à-vis your income.
If you’re in the market for a house or a business loan, lenders will look at your debt as a percentage of your income and may deny you if it’s too high. It means, to them, that you’ll potentially have financial trouble meeting your obligations down the road.
In general, you’re in good financial shape if your total debt payments per month are less than 30 percent of your pretax income (from all types of debt). If your debt payments are 40 percent or above of your pretax income, however, you simply may have too much debt for the income you have. You may not have enough left over for basic expenses or to save for your financial goals.
Contact a Financial Advisor in San Antonio, TX for Debt Advice
The wealth advisors at PAX Financial Group can give you advice on multiple aspects of debt, including sensible debt management. We are full-service CERTIFIED FINANCIAL PLANNER™ Professionals who can help you develop a budget for your expenses and income. A budget helps you manage debt more effectively.
Whether your goal is to reduce your debt or utilize some debt to purchase a home, we can help you meet your financial goals as well as save and invest, plan for retirement, plan for taxes, and engage in estate planning.
