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Debt has become an acceptable part of life in America. Most Americans carry too much debt and struggle each month just to pay the minimum payments on their credit cards. In addition, debt in America is rising. Recent numbers indicate that Americans aren’t uncomfortable with high debt loads. That would explain why America’s household debt is nearly $13 trillion, which is the highest number reached since the New York Federal Reserve began tracking it. During 2016, household debt increased by the largest amount in the last 10 years.
There are many reasons why Americans seem to be comfortable with taking on more debt. In the wake of the Great Recession that began in late 2007, banks significantly tightened their lending standards, and credit was very hard to obtain. In addition, many consumers suffered damage to their credit standing because of the economic downturn and were unable to qualify for new credit. Now that sufficient time has passed for many adverse credit events to drop off credit reports, and the economy has picked up, lenders are more willing to lend and consumers are ready to borrow.
With consumer confidence riding a 16-year high, Americans are moving forward with big-ticket purchases such as automobiles and houses. However, while household debt is very high, delinquency rates on mortgages aren’t. This is a good sign. Auto loans, however, are still extended to many subprime borrowers, and they carry significant rates of delinquency.
Is It True There’s Actually Good Debt?
A debate rages about the different types of debt and if some of it is actually “good debt.” However, the fact remains that not having debt is better than having debt, regardless of what kind it is. It’s sometimes touted that having a mortgage is a good idea because you can get a great tax deduction for the mortgage interest you pay. However, the truth is that many consumers won’t receive a tax benefit from their mortgage interest, and even if they do, the amount of interest they pay over the life of the loan won’t be justified by any benefit they receive.
If there’s no such thing as good debt, then that only leaves us with bad debt. This isn’t to say that there isn’t a thing called reasonable debt. If you’re trying to buy your first home, and you don’t have the cash to buy it outright, a mortgage may be necessary. A reasonable payment that doesn’t exceed 25% of your monthly income could be considered reasonable debt. Consumers should take the shortest loan term possible to minimize the interest paid, and pay off the loan as soon as possible.
Of course, it’s also important to remember what your current financial goals are while considering taking on debt. If you are trying to build up your credit and show that you have more creditworthiness, it may be wise to take on more small manageable debts and bulk up your credit report. This will prove to your creditors that not only can you take on debts, but you also can pay them off on time and in full. On the other hand, if you aren’t trying to actively build up your credit or make a big purchase, it may be smarter to avoid debts and maintain your current financial situation.
What Are the Different Kinds of Debt?
Debt is debt no matter how you try to frame it. Even “reasonable” debt isn’t as desirable as having no debt. Debt can come in all sizes and shapes, so let’s review them so you have a good understanding of the types of debt, as well as how they’re structured.
Secured debt is characterized by the lender holding some form of collateral such as a piece of real estate or a car. Mortgages are considered secured debt, as are car loans, boat loans, and anything that attaches or encumbers an asset as a guarantee for the loan. If you don’t pay the loan as agreed, you could be forced to forfeit the asset.
Unsecured debt has no collateral attached to it. Types of unsecured debt include credit cards and personal loans. Even though there’s no asset attached to the loan, not paying the loan as agreed will still have very adverse effects on your credit standing.
Different Types of Interest Rate Structures
A fixed interest rate loan has a rate that stays the same throughout the life of the loan, while a variable rate can float up and down based on the prime rate. Credit cards usually carry variable rates, as do some mortgages. Variable mortgage loans usually begin with a lower interest rate than fixed rate loans offer; however, depending on how the interest rate changes, they can end up at a higher rate during the life of the loan.
Different Types of Payment Terms
Fixed payment term loans are paid back within a certain timeframe whereas other types of loans can have a variable payment term. Fixed payment term loans can be applied to mortgages, auto loans, and personal loans, for example. Variable repayment loans are used when there isn’t a preset payment schedule or pay-off date. Credit cards usually fall into that category.
What’s Sneaky Debt?
Several types of debt exist that many people don’t even think of as debt. This is because they’re considered by many to be “good debt.” As discussed, there’s no such thing as good debt; all debt is undesirable, even if it’s reasonable. What’s sneaky debt then? Let’s look a bit deeper.
Most Americans who own a home have a mortgage loan they pay every month. Because few people have the cash to pay for a home outright, it’s necessary to borrow money from a bank to purchase the home. Because it’s such a common occurrence, it’s often not even thought of when talking about debt. Make no mistake though; a mortgage is debt, and a risky type of debt at that. Real estate values can change; if the market tanks, you can end up owing more than your house is worth. Alternatively, if you fall on hard times and are unable to make your mortgage payment, you could potentially lose your home to foreclosure. If you want to buy a home and can’t raise the cash to pay for it in full, take the smallest mortgage you can. Also, take a shorter loan term such as 10 or 15 years instead of the customary 30-year mortgage. This could save you tens of thousands of dollars in interest payments over the life of the loan. Whenever you can, make extra payments on your loan so you can pay it off faster. A great deal of financial security exists in having a home that’s free and clear of debt.
2. Car Loans
Cars are a necessity in today’s world since public transportation isn’t always available. Even so, Americans don’t view their cars as just a necessity to get them from here to there. They revere their cars, and the fancier and more expensive, the better. Most consumers don’t realize that the minute a new car exits the car lot, the value drops considerably. That means that in the first few years of owning the vehicle, it’s likely that you owe more than your car is worth.
Americans also aren’t fazed by high car payments. As long as they can make the payment each month, they really don’t seem to care how much they’re paying and for how long they’ll need to pay it. After all, nearly everyone has a car loan nowadays, right?
Not necessarily. Smart consumers understand that a car is just a tool they need to get where they need to go. Even buying a fancy car a year or two old will save you thousands of dollars in payments. Better yet, buying a reliable used car in good condition is the smarter move. A new car these days is expensive, and the interest rates can be high. Can you imagine paying a $500 car loan every month for seven years? Many Americans are doing just that and not thinking twice about it!
3. Student Loan Debt
Student loans have been positioned by lenders, colleges, and even the Federal Government as a necessary part of paying for college and becoming a successful adult. The truth is that student loans are one of the worst things that have happened to our younger generation. When you consider that the average young person carries nearly $40,000 in student loan debt, it’s easy to see why this has become a real problem.
In the last decade, student loans have become very easy to get; they’re promoted by colleges as a way for students to pay for college. Meanwhile, colleges have steadily raised the tuition rates and taken advantage of federal money flowing into the universities. Universities have gotten wealthy on the backs of young people who’ve graduated with a useless piece of paper and entered into a barren job market. This has made paying back these loans nearly impossible, and America’s young people have struggled mightily.
Because student loans have become so easy to get and marketed so heavily to these young people, students haven’t used the tried-and-true methods of applying for scholarships and grants, and working their way through school.
Trade schools, which actually teach students a marketable skill, have been forgotten about as a path to success and a lower cost option. The truth of the matter is that we have far too many young people with useless degrees and not enough skilled workers to fill the positions that actually exist. If you’re considering taking out loans to go to college, you’d do well to look at your options for learning a skill that’ll get you into the workforce faster and cheaper. With not enough skilled workers in the job market, the salaries and benefits are only going up. A trade school education will likely have a much better return on investment than a four-year degree from even a state university. Your lifetime earnings could be exponentially higher as well.
4. Interest-free Offerings
Many retail establishments and online retailers will offer interest-free money that can be very attractive to consumers. After all, 12 months of free interest, for example, lets you put that purchase out of your mind for a year! Most consumers think they’ll pay off the item long before the free interest period is over, but that’s usually not the case. Moreover, many deals will charge you all the back interest if you don’t pay it off in the prescribed timeframe. Retailers count on you still having that balance after the interest-free period ends and subsequently getting to charge you enormously high interest rates for as long as you have a balance. Make no mistake about it; retailers are in the business of making money!
Learning to pay cash for your purchases is a key component of building wealth. Paying interest is a waste of money and a trap that’ll only get you in trouble, not ahead, in the financial game of life.
5. Credit Cards That Offer Rewards
Credit card points and rewards are one of the oldest tricks in the book to get consumers to buy into using credit cards. The truth is that the bank is making far more from interest than it’s giving back to you in “rewards.” Consider this: if you paid cash for your purchases and saved yourself all that money in interest, what would you be able to buy with the savings? It’s probably more than a measly restaurant gift card or some airline miles.
However, if you can take advantage of those credit card benefits, go for it! Just make sure to keep an eye on your finances and that you’re spending within your limits.
The bottom line is that debt is debt, and it’s all undesirable. There’s just no better financial position you can be in than not owing anyone anything. Learn the value of utilizing a cash system to build wealth. With a little discipline, you can actually build your wealth quickly and efficiently. Who knows; you might even become a millionaire!