When you talk about personal finances, one of the big topics that comes up is debt. Ask financial advisors, and they will tell you the good news is that you can get different types of loans. The bad news is that your financial future could be restricted by how much debt you have.
Of course, it isn’t clear-cut. There are many examples of bad debt, some of which are a little more ambiguous, like auto or small business loans. Then, there are examples of good debt, like mortgage debt.
But even ‘good’ debt can be harmful if your financial situation turns negative.
That’s why I will explain why debt is bad in most cases.
Good Debt vs Bad Debt
Debt. When you hear the word debt, it brings up negative feelings. But not all debt is a bad thing. 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. However, housing is generally a sound financial investment. With home improvements and time, you will build up home equity to leverage when you sell your home.
Another type of debt considered “good” is money owed for college, higher 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 debatable, but student loan debt is not as bad as high-interest or payday loans. A student loan has a financial benefit because you can get a better-paid job.
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 everything you want. Quick loans or paycheck advance businesses are plentiful. Even online purchases can easily be put on “credit” payments.
Getting “free money” is so simple 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 alone when everyone else buys 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. However, 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, you have paid $21,600 for the car by the end of the loan.
Credit card debt costs are 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 to spend more money overall. Credit cards eliminate the boundaries that keep you on budget. When you have access to “money” through credit, spending more than you have is very easy.
Have you ever considered how the saying “necessity is the mother of invention” applies to finances? When living on a tight budget, you often must 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 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 is.
The wolf in sheep’s clothing keeps us from the true joy that only comes from successfully completing goals.
When you go into debt, you trade more considerable treasures for temporary happiness. That shiny new car is fun to drive, but it doesn’t seem quite important when you think about how you will have to work a few extra years past when you want to retire.
But due to the monthly payments on that car loan, you don’t put aside an emergency fund. Then unexpected expenses come along (usually on that shiny new car), and you don’t have money on your debit card to pay for it.
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, looking at your budget or getting a bill in the mail will cause stress.
Stress has an impact on your relationships, your day-to-day life, and your physical health. Stress caused by 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 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 complicated 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.
An excellent resource for marriage and money is this binder from The Savvy Couple.
The name Steve Jobs is synonymous with Apple, but three people actually co-founded the company in 1976. Ronald Wayne, along with Jobs and Steve Wozniak, started Apple together.
Wayne was the most financially secure of the three founders. However, he became nervous about being 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 greatly impacted his future. Debt affects your future by blocking opportunities.
If you have no debt and money saved in the bank, you can 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 you have to spend on debt interest into savings instead, you could save a lot 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 challenging to purchase a home.
Debt can prevent you from getting a home loan due to poor financial health. It can also result in a lower loan amount available from banks and a higher interest rate, making your home’s overall cost 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 ensure that people are bringing in enough money to pay off old debts and afford the mortgage payments.
Most lenders want your debt-to-income ratio to be less than 36% (including old debt and your monthly mortgage payment). You can determine 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 gross monthly 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. You can have a good credit history 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. The kind of debt can also make some difference.
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 qualify for a loan or have to pay Private Mortgage Insurance.
When it comes time to purchase a home, having no or low debt will be a tremendous asset.
Why do 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 remain in denial 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 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 spouses don’t support them in their financial goals or because their spending undoes any good effort.
- They feel hopeless: It is easy to feel hopeless in debt. As your debt increases, so does 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 U.S. household with a credit card has $8,398 in debt. Media portrayals, the sheer number of credit options available, and keeping up with the Joneses and entitlement contribute to many Americans believing that credit is a normal part of life.
- No budget: Not having a budget greatly influences 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: People stay in debt because 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 expenses and eliminate things you don’t need. Another way to counter this problem is to look for a higher-paying job 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. Then, they make the minimum payments, and their credit card balance keeps increasing.
- They haven’t made debt freedom a priority: When you make it a priority, it eliminates many of the rationalizations people use to stay in debt.
- They feel guilty: Not giving their children what they want and not living the life others think they should be living. The guilt over not having enough pushes them into a bigger house, more cars, and more elaborate vacations, all on top of their existing debt.
Final Thoughts on Why Debt is Bad…
There are several reasons why people go into debt and why debt is bad for your future.
When deciding on a purchase, specifically something you might have to go into debt for, ask a few questions first.
Do I NEED this?
Can I be patient and save my money for it?
Will this purchase be an asset or a liability?
If I decide to go into debt for this, how fast can I pay it off?