Did you know that there is good debt and bad debt? Good debt is debt that you incur that will increase your overall net worth, while bad debt depletes your net worth. Good debt includes mortgages, home equity loans, and student loans. Bad debt includes credit cards, and sometimes auto and personal loans.
While some people believe that debt is scary, it is not. Nearly all Americans have some type of debt. According to a 2021 CNBC report shared by debt.org, the average American has $90,460 in debt.
Most people cannot buy a home without a mortgage, especially if you purchase your first home early on in your career. If an addition to your home is desired, then a home equity loan can be a good tool to accomplish the goal. Both of these types of loans are considered secured debt, which means that the loan is backed by the value of the property. Secured debt tends to have lower interest rates because there is less risk to the lender to finance the debt since the loan is backed by the property in the event of nonpayment. Since home values typically will keep pace with inflation and overtime you will pay down your mortgage or home equity loan, owning a home can help to increase your overall net worth.
Those that are more educated generally receive a higher income. Investing in your education to obtain a higher paying job is a form of good debt, as a higher income will provide the opportunity to improve your financial wellbeing. According to debt.org, those that received a high school diploma earn on average $38,792 per year, those that receive a bachelor’s degree earn on average $64,896 per year, and those that obtain a doctorate degree earn on average $97,916 per year.
Although mortgages, home equity loans, and student loans can provide the opportunity to increase your net worth, credit cards tend to have the opposite effect. Have you ever paid interest to a credit card lender or possibly even late fees? Yikes! According to creditcards.com, the average interest rate charged by a credit card company is 16.17%. According to CNBC, the average American has about $6,200 in credit card debt. With credit card debt of $6,200 at 16.17% interest rate, about $1,000 of interest will be paid to the credit card company each year. Because of the high interest rates being charged by credit card companies, it is easy to understand how credit cards could be detrimental to our overall financial wellbeing.
Auto loans and personal loans can be either a good or bad source of debt. Most vehicles decrease in value about 10% per year over the first five years of ownership. Since new vehicles will have the largest decrease in valuation the first year of ownership and if a large enough down payment is not made, it could potentially result in being underwater on your auto loan. Being underwater on your loan means that the auto loan is higher than the value of the vehicle, causing a negative impact to your net worth. Based on the circumstances, having an auto loan may be a good source of debt. It will depend on the down payment made, interest rate on the auto loan, and how well the vehicle retains value.
Personal loans can also be a good or bad source of debt, it depends on what the personal loan is used for. If personal loans are used to start a successful business, home improvements, or anything that would help to increase your overall net worth, then it may be classified as a good debt. If the loans are used to obtain unnecessary material items or live above your means, it may be considered a form of bad debt. For a personal loan to be a good or bad debt is contingent on the loans purpose, interest rate, and the positive or negative impact it has to your overall net worth.
Although debt can have a negative connotation, it can be a good tool to help increase your overall net worth. For more information on debt pay down strategies, or to discuss your own personal circumstances, we welcome you to connect with us by reaching out to [email protected].
