With total consumer debt ever rising, credit card issuers offering more and more types of cards, and housing prices (and their mortgages) going up again, it’s no surprise that debt is often considered a path to financial turmoil. The good news is that there is such a thing as healthy debt. Consumers who understand – and learn to manage – good debt can put themselves on the road to financial fitness.
- distinguish which debt is good and which is bad
- know the four types of debt that can be healthy
- evaluate your debt
- carefully check the interest rate
- understand payments
- confuse purchases
- go into debt for something not worthy
- take on any debt, even healthy debt, lightly
- rack up credit card debt
- spend unwisely
Poorly managed debt can lead to trouble, but some types of debt can be healthy in limited amounts. It is important that you learn about different types of debt, and the role each plays in your overall financial situation.
The four types of debt that can be healthy are:
- Student loans – Further one’s education and increase future earning potential.
- Mortgages – Homeownership is an asset that can build equity and net worth.
- Necessary medical bills – One’s health always takes priority.
- Business debts – Often necessary to build a business and future earnings
To be in the healthy category, the debt must be limited, without the ability to continue increasing. A revolving account, such as a credit card, is not limited, and increases as you add more to it. Credit card debt is not healthy debt, and you should do what you can to limit it as much as possible.
To be healthy, the debt’s interest rate must be stable, and at a reasonable, predictable level. Interest rates can be different depending on what type of loan or account it is. Credit card interest rates can range anywhere from 10 percent to 17 percent – or more – depending on your credit score, the type of account and creditor, and other factors.
For a debt to be healthy, it must have regular payment amounts that are manageable within a budget, made on time to avoid late fees, and penalty interest-rate increases.
American culture is founded on consuming. Some purchases are necessary – for medical bills, education, housing – and may be worthy of taking on debt. Others are purely for pleasure – none of us needs an iPod or a daily designer-coffee fix. Learn to manage your finances and budget properly so that you aren’t taking on debt from purchases not worthy of it..
Will you remember why you have the debt in six months? Coffee drinks and music downloads usually can’t pass this test. The debt should only be incurred for something that can appreciate, such as buying a home or investing in a business.
Debt must be weighed carefully and taken on only with a clear plan for repayment. No debt is healthy if a consumer does not have enough cash flow to cover all living expenses, debt repayment and savings – particularly emergency fund savings.
Credit card debt is unhealthy debt, creating more problems than it solves. Most adults find that one card for personal business is helpful. On it, charge no more than you can pay off in full, on time, every month.
Healthy debt is not a green light to spend unwisely. Think carefully. For instance, take out student loans only for education that will further specific goals. Take out a mortgage only if it’s well within your budget. If you need to finance a car, make sure the payment (and car) also fits the budget. And even if taking on debt to build a business, make sure that you have a solid business plan and budget in place.
Remember to focus on lasting value when evaluating whether a debt is healthy or unhealthy. Healthy debt will provide lasting value, and is aligned with a long-term goal (e.g., a mortgage enables you to become a homeowner). Even then, take on no more debt than you can afford each month.