Good Debt vs. Bad Debt
Contributions done by: Mikayla Orser & JW Rayhons
What have you heard about debt? Phrases have been passed around like, “buying a home is good debt” and “get out of debt and become financially free!”. Some questions may arise like:
- What does good debt look like to a consumer?
- What does bad debt look like to a lender?
- How can I be sure I don’t get caught in the debt trap?
These questions, and more, are viable questions to ask when it comes to understand your debt position.
Fay states this, “A simple rule is if it increases your net worth or has future value it’s good debt.” (2019). Graciously put, if the debt doesn’t increase in value over time, it’s most likely bad debt. There are exceptions to this rule, such as student loans, these will be covered later.
Yes, buying a home is considered good debt. Since the Great Recession the housing market has recovered, “with the median home value in the U.S. hit $196,500 in March of 2017…that was a 6.8% increase…” (Fay, 2019). Therefore, buying a home increases your net worth and has future value.
I would venture to say that having a mortgage is the only good debt, however student loans can be considered good if it increases your overall net worth. The idea behind student loans is that you are taking money to better yourself, and by getting a degree you will have better chances at a higher paying job out of college. However, Fay uses a statistic from the Bureau of Labor Statistics that says, “Full-time worker over 25 with only a high-school diploma had a median weekly income of $679 in 2016.” (2019). On the other hand, “the median weekly income for workers with bachelor’s degrees was $1,435.” (2019). Factors such as income will vary depending on your area of the country, your degree choice, and your job choice. If you can leverage your student loans to have a higher paying job in the future, you can consider them good debt.
Bad is not necessarily the opposite of good debt, but bad debt does mean that it depreciates your overall net worth over time. Consider credit cards for a moment, they are typically considered bad debt. However, if you can pay off the balance every month this may help your credit score and make you look more desirable to lenders. However, if you allow your credit card balance to rollover month-to-month this may have negative effects on your credit score. A quick rule-of-thumb is: if you don’t have cash to pay for it, you probably shouldn’t be buying it. Irby states that, “If you are using a credit card for these purchases (clothes or food), it should be intentional, e.g. for better financial management or to earn rewards.” (2020).
Other bad debts to consider, according to Fay are: payday loans and automobile loans (2019). He mentions that payday loans can be 10 to 15 times worse than credit cards (Fay, 2019). Automobile loans are considered bad debt because typically the car you just purchased has depreciated as soon as it leaves the lot. The exceptions would be if you are buying collectible cars, but these are not considered an investment. However, lenders are not blind to the truth that you need a car to get to and from work, which increases your overall net worth. Fay says, “the most financially prudent move is to avoid splurging on a Mercedes when a Hyundai will do.” (2019). I would agree with statement, if you are able to settle for a lower-end vehicle, for the time-being, you may be able to purchase a higher-end vehicle later.
Avoid the consumer mentality that says, “I must have it now or it will be gone” and “I need this because it will make my life better”. These are traps set by the sales and marketing departments of the world. The truth is, if you have more good debt than bad debt, you don’t need that 2020 Audi Q7 when you can afford a 2017 Chevy Equinox.
Take notes of your spending habits. If you use a credit card for every, or close to every, purchase consider if you pay it off every month. If not, turn your focus to paying that off and consider how to adjust your habits for a brighter and prosperous future.
Reach out to a financial professional. If you genuinely don’t know how to manage or handle your debt, we encourage you to reach out to a financial professional who will be able to explain your situation. In addition, a financial professional may be able to help you create a plan for the betterment of your overall finances.
If you are looking for a financial advisor team focused on your unique financial situation, communicates openly, and that puts you and your goals at the center of the relationship, call us at (480) 507-2425 or contact us online. We’d love to meet you.
Mikayla Orser is a Non-Registered Associated Person with Voya Financial Advisors. Mikayla cannot offer securities or advisory services.
The content in this article was prepared by the article’s author. Voya Financial Advisors, Inc. does not endorse its content, and the views expressed may not necessarily reflect those held by Voya Financial Advisors, Inc.
Fay, B. 2019 April 2. Good Debt vs. Bad Debt. Debt.org. Retrieved from: https://www.debt.org/advice/good-vs-bad/
Irby, L. 2020 June 21. Good Debt vs. Bad Debt. Thebalance.com. Retrieved from: https://www.thebalance.com/good-debt-vs-bad-debt-960029#:~:text=%20Good%20Debt%20vs.%20Bad%20Debt%20%201,your%20future%2C%20not%20for%20the%20sole...%20More%20