More than 50 percent of American workers stress over their finances. This certainly makes a lot of sense as the average American has over $130,000 in debt. Fortunately, not all debt is created equal. As a matter of fact, some debt can give you a better financial future.
What’s the Difference Between Good and Bad Debt?
If the debt either has future value or will increase your net worth, this is what is known as good debt. If the debt does none of these things and you don’t have the cash to pay for it, then it’s bad. You can know if you have too much debt by looking at your debt-to-income ratio. To get this number, take all of your monthly debt payments and add them up. Divide them by your monthly income and you’ll get your debt-to-income ratio.
If your debt-to-income ratio is above 43 percent, potential lenders see this as a red flag. Studies show that borrowers with a high debt-to-income ratio will have more problems making their monthly debt payments. It’s rare that you can get approved for a mortgage if your debt-to-income ratio is above 43 percent.
What Is Good Debt?
Good debt lets you leverage your wealth, manage your finances, and handle any emergencies you may have. Some examples of good debt include a mortgage, essential items, consolidating debt, and borrowing for your education. While you may find yourself in a hole in the beginning, you’ll be better off in the future for having taken out the debt.
One of the best types of debt you can take on is a mortgage. That’s because housing prices increased tenfold from 1968 to 2004. While the housing market took a hit during the Great Recession, it has largely recovered. In 2017, the median value of a US house was $196,500. A mortgage acts as one of the best debts you can have.
Home Equity Loans
Home equity loans operate as an offshoot of a mortgage. You can get these loans at a low-interest rate by putting your house up as collateral. Some people use these loans to pay off high-interest debt like credit cards. Others use it to make home improvements that can increase the value of their home. With these loans, you will want to be careful as you can face foreclosure if you can’t make payments.
As a group, Americans owe more than $1.4 trillion in student loan debt. But student loans can be worth the initial cost if you pursue study in a field that will lead to a lucrative career. According to the Bureau of Labor Statistics, a worker with only a high school diploma earned, on average, $679 a week. Those with a bachelor’s degree earned, on average, $1,435 a week.
Small Business Loans
If you decide not to go to college, your best bet for earning a high income is to start your own business. Even if you got your degree, starting a small business can eventually serve as a path to financial freedom. If you don’t have tens of thousands of dollars lying around, you’ll have to consider taking out a small business loan.
However, these types of loans can be more difficult to obtain as lenders see small businesses as a risky investment. The Small Business Administration says that almost one-third of businesses fail within the first two years of operation. But with perseverance, some business savvy, and luck, taking out a small business loan can be one of the best investments you have ever made.
Some Examples of Bad Debt
Credit Cards: The interest rates of your credit cards can often act as the “silent killer”. It can take you years to pay off the balance with minimum payments every month. If you’re not careful with your credit cards, your credit score will take a nosedive and you will find yourself in a lot of financial trouble.
Payday Loans: These are short term loans that you take out to get you out of a financial emergency until your next payday. The interest rates are so hefty that you will want to avoid them at all costs.
Car Loans: New cars lose value ten minutes after you drive them off the lot. But if you need a car to get to work, the interest rates are fairly low. Just don’t splurge on a Mercedes-Benz when a Toyota will get you to work just fine.
If you must take on debt, you can look at established financial institutions such as banks and credit unions or newer lenders such as Gladiator Lending. Whether you decide to go with your local bank or Gladiator Lending, make sure you educate yourself on the terms of the loan before you take on the debt.