When it comes to debt, we have a simple philosophy: Debt is dumb.
Some people underestimate their pile of debt because they think “good debt” doesn’t really count against them. But here’s the deal: there’s no such thing as “good” debt.
What Is Debt?
No matter how people try to sugarcoat it, any time you owe money to anybody, that’s debt. Our culture may say certain types of borrowing doesn’t count as real debt—but that’s just not true.
Debt can turn up in many forms, so it’s good to know the different ways it can be described:
- Relies upon some form of collateral
- Commonly used for home mortgages and car loans
- Doesn’t use collateral
- Used for credit cards and personal loans
Fixed interest rate
- When the interest rate remains the same throughout the term of the loan
- Used for home mortgages
Variable interest rate
- When the interest rate can fluctuate over time
- Used for credit cards
Fixed payment term
- When the whole loan has to be paid back by a certain time
- Used for home mortgages and personal loans
Variable repayment period
- When there is no set date for the debt to be repaid
- Used for credit cards
5 Sneaky Types of Debt
You’ve probably heard that mortgages are “good” debt. People will say you’re “leveraging” your debt because you can write off the interest on your taxes and the home appreciates in value!
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But here’s the deal: if you’re going to take out a home loan, you should follow some solid guidelines (like taking out a 15-year, fixed-rate mortgage with a monthly payment that’s no more than 25% of your take home pay).
But even then, any mortgage still involves risk. Your home’s value could drop and have you end up underwater. You could face a catastrophe and not be able to pay your mortgage.
So, if you can swing it, putting 100% down in cash is always the most ideal option.
2. Car Payments
We love our cars, don’t we? We love them so much that we walk onto car lots and drive off with brand-new vehicles—and huge car loans.
Many people will try to say you can’t buy a car without a loan attached to it and that new cars are the only “safe” option. So, massive car loans become acceptable debt. It’s just part of being “normal,” right? And if you can manage the $600 monthly payment, what’s the big deal?
But consider this: a car’s value tanks just by driving it off the lot, and then drops another 60% after the first 5 years!1 When you factor in how interest rates are usually pretty high and loan periods are getting longer, suddenly it doesn’t seem so smart.
Skip the new car and pay cash for a good, reliable used one that will get you from point A to point B.
3. Student Loans
Student loans are another example of what many consider worthwhile debt. But the truth is, student loans hurt a lot more than you might think.
In fact, they are the biggest roadblock to the financial success of this generation. The average student loan debt per student is about $38,792, and the grand total of outstanding student loan debt has reached $1.58 trillion.2,3
Today’s 20-somethings grew up hearing things like, “You can’t go to college without debt. Student loans are an investment in your future. You can’t get ahead without a fancy education!”
The unfortunate result? Many college students take out loans without understanding they’ve jumped into a deep pit with a nasty boa constrictor. Suddenly, they’re looking at a lifetime of debt that makes buying a home, getting married, or starting a family way more difficult than it should be. Thanks for nothing, student loans.
If you have student loans, kick it into high gear to start paying off debt pronto. And if you’re considering taking out new loans, walk away. Believe it or not, you can graduate from college without student loans hanging around your neck. Save up and pay cash, apply for scholarships and federal grants, or work your way through school.
4. Credit Card Rewards
We can hear you now! Well, this is the one thing I disagree with Dave on. I use my credit card, pay it off each month, and rack up major rewards. Yes, we do see your Facebook comments.
Bravo to you for paying off your credit card in full each month. But the truth is, the majority of people just don’t do that. The Federal Reserve has found that Americans are approaching $1 trillion in credit card debt.4 The numbers don’t lie—not everyone is “paying it off each month.” In fact, the average American household with credit card debt has a balance of $14,821.5,6,7
Debt is debt. Your free T-shirt and flight miles are really great and all, but credit card rewards won’t help you become a millionaire. Learning to manage your money and pay for things in cash? Now that will.
5. Interest-Free “Deals”
The last time you needed to buy furniture, you probably heard a sales pitch that went something like this: Buy today and pay no interest for a full year! Ninety days same as cash!
That’s not debt, right? Not if you pay off that dining room set before the interest kicks in? False. That salesperson isn’t there to do you any favors. They know the chances you’ll pay in full before 90 days are slim to none. The store is in business to make money. When you sign on the dotted line, they’re in for a profit.
So, the next time a salesperson tries to sucker you into one of these deals, offer less than the asking price and pay with cash. You’ll get a better price and avoid debt.
How much debt do you have?
Unsure of how much debt you actually have? You’re not alone. According to a recent study, Americans underestimate their credit card debt by an average of about 37% and their student loans by about 25%.8
A lot of people don’t know how much they owe because they’re too afraid to open up the bills, don’t understand how it all works, or simply haven’t taken the time to add it all up. That does nothing to help you with debt reduction. Sticking your head in the sand won’t make it all magically go away either. After all, knowledge is power.
You can use our simple debt calculator to determine how much debt you have and how long it will take to pay it off. Then, get to work paying off your debt completely by using the debt snowball method. It’s doable, and we’ll show you how!
Ready to get out of debt once and for all? Financial Peace University (FPU) will guide you through our proven, step-by-step plan to master budgeting, pay off debt, save and invest for your future. Start FPU today and make progress toward your money goals faster!