Why Mortgages Are Considered “Good Debt”
Debt, the scariest 4-letter word known to adults across the US. According to Experian’s 2019 Consumer Debt Study, total consumer debt hit $14.1 trillion, with the average American carrying nearly $90,500 in personal debt. With staggering numbers like this, it’s no surprise that renters are concerned with taking on a large loan, such as a mortgage. The good news is, mortgages are actually considered “good debt” to have.
So, what’s the difference between good and bad debt? No rule book states one type is better than the other because depending on your financial situation, taking on any kind of debt could be the wrong decision*.
Types of Debt
Before we break down the differences between good and bad debt, you need to know what types of debt exist. Most types of debt can be categorized into the following groups.
Secured debt is any debt backed by an asset for collateral purposes during the length of time that you’re borrowing the money. A car loan is an example of secured debt because the car acts as collateral, and the lender has the power to repossess the car should the borrower be unable to pay back the loan. This type of debt is usually obtained based on the value of the collateral and your creditworthiness.
On the other hand, unsecured debt lacks collateral and typically has a higher interest rate because of this; the lender assumes the debt if the borrower fails to make payments. Typically, when the borrower is approved to take on an unsecured debt, they can borrow freely from a predetermined, approved limit from the lender. Keep in mind, falling behind or missing payments can cause significant damage to your credit score. A few examples of unsecured debt you may already have:
- Medical bills
- Credit cards
- Signature loans
- Utility bills
- Retail installment contracts (gym memberships, etc.)
Revolving debt allows consumers to borrow as often as they need up to the preapproved limit. This type of debt can be unsecured, like the use of a credit card, or secured, in the instance of a home equity line of credit.
Consumers looking to borrow a lump sum to be paid back over time would take on an installment debt. An example of this would be obtaining a student loan, a mortgage, or a large car loan.
“Good debt” can be considered an investment that will grow in value or generate long-term income. For example, home loans are considered good debt because homes can appreciate over time. Mortgages are typically one of the lowest interest rates available to consumers.
Obtaining a student loan or a reasonable car loan is also considered a good debt to have because they contribute to your long-term success. That being said, a car loan that exceeds your ability to pay back every month or student loans for a degree you don’t plan to finish are examples of ways good debt can quickly turn bad.
Credit cards are an example of bad debt if not used properly. The average American household with a credit card carries at least $8,300 in credit card debt. Payday loans and luxury car loans (when a non-luxury car will do) are also considered bad types of debt to have.
Do you need this debt? Do you have the cash on hand to pay this debt off (not including student or home loans)? Will this debt help create long-term wealth? If the answer is no to any of these questions, you may want to rethink taking on this debt.
Maintaining Debt While Working on Credit
Is your credit score suffering due to too much debt compared to your available credit limits? We’ve come up with three tips for how you can manage your debt load while maintaining a credit profile.
Stop Accumulating Debt
If you have several credit cards with high-interest rates and your debt is snowballing out of control, you need to take action now before it gets even further out of hand. Need a few ideas? Try cutting incidental expenses, increasing your income with the addition of a part-time or freelance job (if that’s a skill set you’re able to accommodate), or applying for a balance transfer credit card with a lower APR.
Balance Transfer Your Credit Cards
Balance transfers are more of a quick fix if your cards all have high-interest rates, and you should not use that as a long-term solution for controlling your debts. A balance transfer is a relatively simple concept: You apply for a new credit card with a lower interest rate—preferably one with a 0% rate for a year or more. Then you move your balance(s) to that card from your existing card(s). Read more about it here.
Start an Emergency Fund
Instead of relying on high-interest credit cards to help carry you through emergencies such as car repairs, unexpected home maintenance, medical emergencies, etc., you should make every effort to establish an emergency savings fund. There’s a common suggestion that you should have three to six months’ living expenses saved up as your emergency fund. Don’t let that discourage you—even a small amount to start with can help.
Don’t let the fear of debt keep you from becoming a homeowner!
Connect with a Mortgage Advisor today for a complimentary consultation to learn more about how a home loan could help create long-term wealth.
*Speak with a financial expert about your personal profile before making any important decisions.Debt, debt management, good debt, Mortgages
Categories: First-Time Homebuyers