Debt, often regarded as a chilling four-letter term to adults across the US, can be quite overwhelming. As stated in Experian's 2019 Consumer Debt Study, the total consumer debt soared to $14.1 trillion, with an average American shouldering nearly $90,500 in personal debt. Given these startling figures, it's understandable why potential homeowners are hesitant about assuming a substantial loan such as a mortgage. However, the silver lining is that mortgages are typically classified as "beneficial debt". So, what differentiates good from bad debt? There's no definitive guide indicating one as superior to the other, as the appropriateness of any debt largely depends on your unique financial circumstance.
Categorizing Debts Before diving into the distinctions between beneficial and detrimental debt, let's familiarize ourselves with the common types of debts:
Secured: This form of debt, backed by an asset serving as collateral throughout the borrowing period, often relates to loans like car loans. In case of payment failure, the lender holds the right to seize the collateral. The value of the collateral and your creditworthiness significantly influence the obtainment of this debt type.
Unsecured: In contrast, unsecured debt isn't backed by collateral and typically carries a higher interest rate. Approved borrowers can utilize an approved limit from the lender, though failing or lagging in payments can severely tarnish your credit score. Common forms of unsecured debts include medical bills, credit cards, signature loans, utility bills, and retail installment contracts (like gym memberships).
Revolving: This debt type allows consumers to borrow repeatedly up to a preapproved limit. It can either be secured, like a home equity line of credit, or unsecured, similar to credit card usage.
Installment: Ideal for consumers desiring a large sum to repay over time, examples of installment debt include student loans, mortgages, and substantial car loans.
Beneficial Debts "Beneficial debts" typically represent investments that appreciate in value or yield long-term income. For instance, home loans are perceived as beneficial debt as property values generally rise over time. Mortgages offer one of the lowest interest rates to consumers. Student loans or manageable car loans, which contribute to your long-term prosperity, also fall under this category. However, excessive car loans or unfinished degree-related student loans can swiftly transition beneficial debt into a burden.
Detrimental Debts Mismanaged credit card usage often leads to detrimental debt. The average American household with a credit card bears a debt of at least $8,300. Payday loans and luxury car loans (when an affordable car suffices) are likewise regarded as unfavorable debts. If you lack the requisite funds (excluding student or home loans) to settle the debt, or if the debt doesn't contribute to long-term wealth, it's prudent to reconsider the decision.
Debt Management While Improving Credit Struggling with a dwindling credit score due to excessive debt in comparison to available credit limits? Here are three useful tips to help maintain your debt while improving your credit profile:
Halt Debt Accumulation: If high-interest credit cards and spiraling debt are overwhelming you, immediate action is needed. Some solutions could include trimming non-essential expenses, supplementing your income with a part-time or freelance job, or applying for a lower APR balance transfer credit card.
Consider Credit Card Balance Transfer: While this can offer a short-term solution for high-interest rate credit cards, remember it's not a sustainable method for debt management. The process involves applying for a new, lower-interest rate credit card and shifting your existing balances to the new card.
Initiate an Emergency Fund: Instead of relying on high-interest credit cards for unexpected expenses like car repairs, home maintenance, or medical emergencies, strive to establish an emergency savings fund. While the general advice is to save three to six months' worth of living expenses, starting small can also make a significant difference.
Don't let the fear of debt deter your homeownership dream!
Get in touch with a Mortgage Advisor at CrossCountry Mortgage today for a free consultation, and learn more about how a home loan could foster long-term wealth generation.
*Please consult a financial expert based on your individual financial profile before making critical decisions.
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