Like '90s fashion, debt gets a bad rap. But it’s not all bad. See: mom jeans and tiny sunglasses. So we teamed up with Fidelity to break down the difference between the good and the not-so-good. Because trends come and go...but (certain kinds of) debt can be forever. Let’s start with the good.
Always. Good debt is anything that is likely to increase your net worth — whether it’s a purchase whose value will appreciate over time or an investment in yourself that will have a financial payoff. Enter:
Home mortgages. As long as you can afford to put down a good-sized down payment (for some, that’s 20%), a home mortgage is typically considered good debt because you may be able to sell your place for a profit. Or at least recoup some of the money you’ve spent on it. Check out a breakdown of home loans here.
A small business loan. Whether you want to turn that startup dream into a reality or are already an entrepreneur, a small business loan may help you launch or grow your biz and increase your earnings along the way. You can use the borrowed cash to fund anything from manufacturing a new product to expanding an existing company into different markets — and pocketing the profits.
A degree. A college education can spell good debt when it boosts your future net worth. Think: more job opportunities and higher paychecks. Good for you, grad.
Okay...but what about the student loan crisis?
Time for a tangent. Not all student loans are created equal. Federal loans offer: lower interest rates that are fixed (as in, they don’t fluctuate), income-driven repayment options (which reduce your monthly payments if your outstanding debt is a big percentage of your income), and loan forgiveness programs (government employees, teachers, and nonprofit staffers might be eligible to have their loans forgiven). Some government loans are even subsidized, so you’re not responsible for paying interest while in school. Private loans, on the other hand, can sometimes put you in a bind(er). They’re issued from banks, credit unions, or schools. The rates tend to be high and might be variable, so they can change without warning. Net-net, keep an eye on them. Not cool.
Yep. So be careful before refinancing any federal student loans into private loans. Even if you do find a lower rate. (Pro tip: if you refinance, you have to work with a private lender.) You might regret giving up some of those federal loan perks. So, I have good debt. What now?
Unlike bad debt, there’s no urgent need to pay this off ASAP. So make your payments on time, and budget for them along with your other money goals — an emergency fund, retirement nest egg, vacation savings, etc. Just remember: It’s true you can have too much of a good thing. Taking on more debt than you can handle (regardless of the financial opportunities it opens up) can throw you off track if you let it get out of hand. Speaking of the bad...let’s get into it.
Bad debt is when you borrow money to buy something that loses value over time and won’t boost your net worth. Examples, please?
Car loans. A new ride loses about 60% of its value within the first five years. Then it continues to depreciate until it’s worth nada. Want to make your wallet happy? Pay cash for a used car, and hold onto it for as long as possible. If you do decide to finance a vehicle, seek a loan with little or no interest and pay it off fast. What else?
Play your cards right. Carrying a credit card balance is pretty much bad debt 101. The interest rates are staggering, plus most of the stuff you swipe to buy — from clothes to gas to groceries — plummets in value as soon as you step out of the store. Are you saying I should ditch my card?
Not exactly. It’s a myth that credit cards should be avoided. Using them responsibly can earn you rewards like flights, hotel stays, gift cards, or cash. It also improves your credit score, which makes it easier to buy a home or car down the road, and leads to lower interest rates if you borrow money. Just be sure to pay off your balance in full every month. If you wouldn’t be able to afford whatever you’re craving in cash today, then put the card away. Sooo…I’ve got debt I haven’t been dealing with.
Enter, a no-sweat game plan. Write a list of what you owe, beginning with the highest interest rate and working your way down. Be sure to make the minimum monthly payment on each debt. And focus on chipping away at the one with the highest interest rate first to save the most money in interest. But what if I don’t have extra money for debt?
Go minimalist on your wallet. Cut back on unnecessary purchases so you can pay it off faster. One strategy to buffer against mindless spending: after you add items to an online shopping cart, wait a day before clicking “buy.” And find cheaper alternatives — anything from downloading free library books to brown-bagging your lunch. Uh, not sure I have the willpower for that.
Old habits die hard. So try a cash diet. Pop your credit card in the freezer and take out a certain amount of spending money from the ATM each week. Once it’s gone, it’s gone — you’ll have to make do until the next week. If you’re really in a hole, consider a more drastic measure like moving to a cheaper area or giving up your car. Phew. I think I can handle it.
Keep going. It can be hard to save when a chunk of your money is going toward digging yourself out of debt. Need some extra help? Fidelity has your back. They can help you build a financial strategy that fits your needs. Get started. theSkimm If you know what you’re getting into, debt-wise, it’ll be much easier to manage down the line. And if you’re already in bad debt, hit pause now to make a plan. You got this.
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