If you are like most Americans, you are living with a lot of debt. But some of that debt could be good.
The average amount of debt for the average citizen hovers around $32,000 to $37,000, which does not include a mortgage. For people between the ages of 45 and 54, their debt including a mortgage averages around $134,000.
If you are someone who has a lot of debt, do you know which is good debt and which is bad? Did you even know debt could be good?
What is good debt?
Good debt will have low-interest attached to it and can help you increase your income or net worth. When you have good debt, it enables you to handle your finances effectively. If you add up all your monthly debt and divide it into your monthly gross income, you will get your debt-to-income ratio. You will generally want this number to be under 40 percent. Potential lenders will consider you a risk for a loan if you are above 43 percent. If you are above this number, you are most likely carrying a significant amount of bad debt.
Examples of good debt:
- Student loans - Since this is an investment in your future and a way for you to be a productive member of society, they will commonly have low interest rates.
- Mortgage - This will likely be the biggest financial decision you will make in your life. It is important to stay within your budget and not purchase more home than you need. A mortgage can be refinanced to make your payments more manageable.
- Car loan - For most people, a car is an essential part of their life since they need it to get to work, get kids to school and activities and various errands. Loans should be four years or less with around a 20 percent down payment.
What is bad debt?
Bad debt is characterized by debts that severely hamper your financial situation. Debts that have high or variable interest rates are the main culprits, especially if the debt was accrued from discretionary items that will lose value over time or lose value after purchase.
Examples of bad debt:
- High-interest credit cards - Some credit cards can have low interest and carry debt for critical items. However, rising interest rates, impulse purchases and late fees can quickly turn your credit card into bad debt.
- Personal loan for everyday items - If you feel like you need a vacation or to re-stock your closet with new clothes, taking out a personal loan may not be the best idea. A personal loan for something useful like a loan consolidation might be able to move it up to good debt, but you will need to watch your spending if it is for something else.
- Payday loans - Since these types of loans usually come with high interest rates, they can be the epitome of bad debt. The lure of quick money may be attractive to you to solve your financial problems, but you are most likely just transferring your problem from one place to another and probably making your situation worse.
If you are facing extreme debt and feel you are being overwhelmed with paying bills and keeping your head above rising financial waters, you should speak with an attorney who can help. A discussion about your financial options can be useful and you may find out you are a good candidate for a bankruptcy filing.
