Good Debt vs Bad Debt
Debt. When you hear the word debt it definitely brings up negative feelings. But not all debt is a bad thing. In fact, most experts agree that there is such a thing as good debt. So, here’s why debt is bad.
So what is the difference? In a nutshell, good debt is when you owe money for something that will be financially beneficial in the long run.
When you get a mortgage, you are technically in debt for your mortgage amount. But housing is generally a sound financial investment. With home improvements and time, you will build up equity in your house that you can leverage when you sell your home.
Another type of debt that is considered “good” is money owed for education or training. If you have to get a loan for college or trade school that will help you earn more money in the future, that is considered good debt. This is up for debate.
Bad debt is money owed for pretty much everything else. Cars depreciate along with every other physical product. When you take out a loan or use a credit card to purchase items that you won’t be able to sell for a profit, that is bad debt.
Debt Driven Society and The Drain on Your Purse
Unfortunately, we live in a debt-driven society. Every other commercial or billboard advertises credit cards to fund your every want. Quick loans or paycheck advance businesses are plentiful. Even online purchases can easily be put on “credit” payments.
It is so simple to get “free money” that loans or credit might be hard to resist. But debt, even in tiny increments, is like having a drain on the bottom of your purse or wallet.
These little debt leaks slowly and surely pull from your budget and diminish your savings. If you aren’t careful, future financial goals and long term plans like retirement will disappear $10/month at a time.
Being financially aware and frugal in your spending might make you feel all alone when everyone else is buying whatever they want. But being different in a debt-driven society will give you peace and financial security.
How Does Being in Debt Affect You?
Being in debt will give you the temporary pleasure of getting what you want, when you want. But debt has numerous detrimental effects that might surprise you.
Debt causes you to spend more
When you look at debt over your loan repayment period, the overall cost of the item increases. For example, if you finance $20,000 to purchase a car, with a 3.99% interest rate for 4 years, by the end of the loan you have paid $21,600 for the car.
The cost of credit card debt is even higher, with some credit cards charging up to 34% in interest! If you purchase a $400 television on a high-interest credit card and pay the minimum monthly payment, in the end, the television cost would almost be doubled at $754.
Not only does debt COST more, but it also makes it easier for you to spend more money overall. Credit cards eliminate the boundaries that keep you on budget. When you have access to “money” through credit, it is very easy to spend more than you have.
Kills creativity
Have you ever thought about how the saying “necessity is of the mother of invention,” applies to finances? When you are living on a tight budget, you often have to get creative to make things work.
Debt is the easy way out of critical financial thinking. When you use credit to solve a problem, it kills your creativity.
Financial creativity can supply you and your family with some of your most treasured memories. Remember the year you could only afford that ugly Charlie Brown Christmas tree that kept falling over?
Or what about the amazing homemade chocolate cake recipe you found because you couldn’t swing a bakery cake for dad’s birthday?
Keeps you from reaching financial goals
One of the most detrimental ways that debt affects you is by blocking you from reaching your financial goals. Debt comes into our lives in such a sneaky innocuous way that it doesn’t feel as bad as it really is.
It’s the wolf in sheep’s clothing that keeps us from the true joy that only comes from the successful completion of goals.
When you go into debt you trade bigger treasures for temporary happiness. That shiny new car is fun to drive, but when you think about how you will have to work a few extra years past when you wanted to retire it doesn’t seem quite so important.
Can cause stress
Having debt hanging over your head makes life less enjoyable. Sure, there are times that you might be able to forget about the money you owe. However, every time you look at your budget or get a bill in the mail it will cause stress.
Stress has an impact on your relationships, your day-to-day life and your physical health. Stress caused from debt can be eliminated through careful budgeting.
Marital fights from debt are common
About ⅓ of married couples say they often fight about money. In one study couples reported that their fights about money are more “intense and significant” than arguments about other matters.
“Opposites attract,” and it isn’t uncommon for people considered spenders to marry someone who is more of a money hoarder. When there are two conflicting beliefs about whether to spend money or save money, debt is an understandable hot button.
There are plenty of other difficult things that happen in life. Taking debt out of the equation by communicating about money and setting mutual goals and money expectations will help eliminate this common marriage stressor.
A great resource for marriage and money is this binder from The Savvy Couple.
Blocks opportunity
The name Steve Jobs is synonymous with Apple, but there were actually three people who co-founded the company in 1976. Ronald Wayne, along with Jobs and Steve Wozniak started Apple together.
Wayne was actually the most financially secure of the three founders. However, he became nervous that he would end up responsible for the business debts.
Just 12 days into his role with Apple, he sold his 10% stake in the company for $800. Since then, the value of Apple has grown to more than $2 trillion. If Wayne had kept his share, it would be worth over $201 billion today.
Wayne wasn’t in debt, but his financial insecurity had a huge impact on his future. Debt affects your future by blocking opportunity.
If you have no debt and money saved in the bank, you are able to take advantage of opportunities that come your way.
Whether that means a great sale on airfare for a vacation to visit family or the possibility of investing in a company, opportunity makes life more exciting and fun. Don’t let debt block your opportunities.
Decreases the amount you save for retirement
Debt decreases the amount you save for retirement by robbing you of potential savings. We’ve all seen the charts that show how money accrues interest over time.
If you put the money that you have to spend on debt interest into savings instead, you would be able to save a lot of money towards retirement.
Even the debt you go into buying non-essentials could be used towards retirement savings.
Putting your extra pennies towards retirement instead of using them to pay off debt could mean the difference between a comfortable retirement, and a stressful retirement where you are still stretching to make ends meet.
Making the ability to purchase a home harder
Debt will affect your future by making it more difficult to purchase a home.
Debt can potentially eliminate you from getting a home loan. It can also result in a lower loan amount available from banks and/or a higher interest rate making the overall cost of your home significantly higher.
Banks determine who can receive a loan by looking at several factors. One of the most important is your Debt To Income ratio (DTI). Lenders want to make sure that people are bringing in enough money to pay off old debts as well as afford the mortgage payments.
Most lenders want your DTI to be less than 36% (including old debt and your monthly mortgage payment). You can figure out your DTI by dividing your monthly debt amount by your monthly income.
For example, if your anticipated monthly mortgage is $1,200, but you have a $500 car payment and minimum credit payments of $300 while making $5,000 a month income, your DTI would be 1,200+500+300 divided by 5,000 which equals 40%. This DTI will most likely eliminate you from getting a mortgage.
Another factor in being able to buy a home is your credit rating. Now you can have good credit and still be in debt by paying your minimum monthly bill regularly.
However, if you have a lower credit score you could be rejected for a home loan, or at the very least have a much higher interest rate.
Buying a home also requires a down payment, preferably 20% of the home purchase price. If you don’t have a down payment saved up because you have other debt, you won’t be able to qualify for a loan or you will have to pay Private Mortgage Insurance.
When it comes time for you to purchase a home, having no or low debt will be a huge asset.
Why People Stay in Debt?
We’ve looked at all of the ways that debt can affect us negatively, so it begs the question, why in the world do people stay in debt?
There are many reasons:
- Addicted to stuff-Our heavily consumer-driven society LOVES to have all of the things. Media advertisements are constantly feeding us the latest and greatest and it is easy to get caught up in the thrill of having more.
- Wanting to keep up with the Joneses- It is very easy to fall into the trap of “keeping up” with our friends, families, and neighbors. People stay in debt because they are so focused on having the same as everyone else.
- Denial about their finances- many people stay in debt because it is easier to stay in denial about their finances than to face the task of clearing up their debt.
- Entitlement- Over the past several years, entitlement has reared its ugly head in our society. Instead of recognizing that hard work most often results in plenty, people look at others who have more than them and demand that they have the same. Debt is the easy way to get things we “deserve” whether or not we can afford them.
- They have the wrong mindset (not good with money, etc): Your mindset directly affects your finances. If you believe that you aren’t good with money without trying to fix that way of thinking, your spending will reflect that negative belief.
- Their spouse isn’t on the same page: Debt in families can be driven by only one member. Some people are in debt because their spouse doesn’t support them in their financial goals or because their spending undoes any good effort.
- They feel hopeless: It is easy to feel hopeless when you are in debt. As your debt increases so do the despair that makes you think you can’t ever get a handle on your finances.
- They think debt is normal: Debt has been normalized in our society. On average, each household in the U.S. that has a credit card has $8,398 in debt. Media portrayals, the sheer number of credit options available along with keeping up with the Joneses and entitlement contribute to many Americans believe that credit is a normal part of life
- No budget: Not having a budget has a huge influence on keeping people in debt. When there are no boundaries, you will spend using whatever means you have available. Too many people without a budget turn to a credit card when their income doesn’t cover the cost of something they want or need. This cycle of overspending and going into debt will continue until budget boundaries are created and kept.
- They don’t make enough money: An understandable reason people stay in debt is that they don’t make enough money to cover their costs. If this is the case, I encourage you to take a closer look at your costs and eliminate things you don’t need. Another way to counter this problem is took look for a higher paying job, and/or start a side hustle to increase your incoming funds.
- They rely on credit cards: People in chronic debt rely on credit cards. Instead of a credit card being the last option, it is where they turn to first when spending money.
- They haven’t made debt freedom a priority: When you make debt freedom a priority, it eliminates many of the rationalizations that people use to stay in debt.
- They feel guilty: Not giving their children what they want and not living the life that others feel they should be living. The guilt over not having enough pushes them into more house, more car, more elaborate vacations; all on top of their existing debt.
Final Thoughts on Why Debt is Bad…
There are a number of reasons why people go into debt and why debt is bad for your future.
When deciding on a purchase, specifically something that you might have to go into debt for, ask a few questions first.
Do I really NEED this?
Can I be patient and save my money for it?
Will this purchase be an asset or a liability?
If I do decide to go into debt for this, how fast can I pay it off?