Not all debt is created equal
Debt seems like a dirty word, and it can be — but there’s more to it than simply money owed. There are many different kinds of debt, each with different characteristics. What is “good debt,” and what should you be paying off first? Here’s a look at the common types of debt we face in our personal finances and a strategy for dealing with them.
The first step in debt management is making sure you’re protected. Prioritize income protection in the form of disability insurance, then save enough money to cover at least nine to twelve months of expenses. Nothing can worsen debt struggles faster than being caught unprepared for a major expense. Once your income is safe and you have a nest egg, start reviewing different types of debt and paying them down.
The worst kind of debt this side of loansharking, credit cards charge a high interest rate (sooner or later), and the ugly truth is they’re engineered to suck you dry. Even though everyone knows better, most Americans with credit cards carry some amount of debt.1 If you’re looking at your debt and wondering what to tackle first, credit cards are a top priority. In recent years, the popularity of “personal loans” offered by the fintech sector has soared. These loans don’t require collateral and tend to offer lower rates than credit cards2 — but beware, you’re still throwing away money if you carry a balance. Think of these in the same way you do credit cards — and pay them off before you pay too much.
Auto loan debt has been surging in recent years, as has the rate of default. For most adults, cars are not so much investments as necessities — you may need a working car to get to and from your job, or to find a job if you’re on the hunt. When buying, remember that cars depreciate, so shop for value, not fancy features. A car loan is a cost of doing business for many people, but as a depreciating asset paying off its debt should be a priority.
Good debt is debt that will benefit you in the future — think of it as an investment that is growing as you’re paying it off. The ultimate example of good debt is a mortgage on a house or other property you’ve bought. Historically, housing prices climb faster than the interest rate, so the mortgage you’re paying can be an investment that is making you money (bubbles aside). If you keep up with the payments and pay off your mortgage, you may end up with an asset that’s worth more than you paid for it. While interest on the loan means you’ll pay more than you would if you’d bought the home with cash, you’ll still be making money.
Student debt used to be considered good debt — an investment in your future. The logic is that degrees pay for themselves over a lifetime by boosting your salary. If your degree qualifies you for a high-paying field — as with many STEM fields of study — that can still be true. But the number of struggling college grads today suggests that times have changed. If you’re considering taking on student debt, be mindful of the cost of your degree and future career prospects. If you have student debt, you can also consider refinancing, which means combining your private and federal loans and paying it all off at a lower rate.
Medical debt occurs when you can’t pay your medical bills in full at the time you’re billed — often after a major procedure or an extended hospital stay. Medical debt is reported as the number one cause of bankruptcies in the U.S., and even illnesses or injuries that result in a long-term disability can lead to ongoing medical bills and a loss of income over time.3 That’s why it’s important to have protection in place in the event of a disability. Medical debt is a widespread condition that irks providers nearly as much as it stresses out debtors, so some providers are willing to arrange a no-interest or low interest payment plan, or even reduce your bill to avoid losing money by sending you to a collections agency.4
In today’s economy, it can be easy to slip into debt, and hard to know how to climb out of it. A financial professional can help you make smart debt decisions, anticipate life’s big-ticket purchases, and work with you to plan a debt-free future.
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2021-131068 Exp. 12/2023