Debt: The (Sort of) Good, the Bad, and the Ugly

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By Scott E. Halliwell, CFP®, ChFC®, CLU®, CWS®

As a nation, we the people of the United States have a lot of debt.

According to the March 2012 Federal Reserve Statistical Release, U.S. consumer debt topped $2.5 trillion — not including mortgages, home equity notes, or other debts secured by real estate. Mortgage-related debt hit just about $13.5 trillion, according to a separate Federal Reserve Board report.

But is it as negative as it sounds? It depends on who you're asking, and it's a debatable issue for sure. When it comes to classifying some of the most popular forms of debt, here are the categories I would use: The (sort of) good, the bad and the ugly.

The (Sort of) Good

So you were probably thinking this category would just be straight-up labeled "The Good," right? Why qualify it with (sort of)? Here's the thing: I personally wouldn't go as far as to call any debt "good." Necessary at times? Yes. Potentially helpful? Yes. Good? No. Even so, the following types of debt are generally more tolerable than others.

Student Loans — Post high-school educations are expensive and tend to occur at a point in life when few people could have saved enough to pay for one on their own. As a result, debt is often a necessary evil to get a degree. It's important though, to only borrow what is absolutely necessary and do all you can to ensure that your debt leads to a degree and a better standard of living. Remember, what you borrow when you're 18 could still be consuming a piece of your paycheck when you're 28.

Mortgage Loans — Another item falling squarely on the expensive list is a house. And like college educations, the likelihood of being able to pay cash for one is but a dream for most people. Consequently, debt becomes almost a necessity. But the name of the game should be to underdo it not overdo it. Just because a bank will lend you money to buy a mansion, doesn't mean you need it or that you should buy it. Also, tax savings alone are rarely reason enough to justify a home purchase. You may be able to deduct mortgage interest and real estate taxes on your tax return, but before you can deduct them, you have to be able to pay them.

The key here is that the debt has to be thoughtfully incurred and properly planned for. Now, let's look at "The Bad" and "The Ugly."

The Bad

Though fairly common in our society, the following types of debts really should be avoided or at least minimized if at all possible.

Auto Loans — Vehicles are expensive, and they've almost become a necessity in many parts of the country. Still, that doesn't mean they have to drain you financially. You should think "practical," not "status symbol" if you have to finance the purchase of a car. If your all-in transportation costs (car payment, gas, maintenance, etc.) exceed 10% of your gross pay, you might be driving more car than you should be.

Credit Cards — Using credit cards for convenience is fine. Using credit cards for things you can't afford is not. If you don't pay off the balance each month, you'll have to pay finance charges on top of the amount originally charged. It's like walking into a store and offering to pay more for an item than the amount on the price tag. It just doesn't make much sense.

The Ugly

Now we get to the stuff from which nightmares are made.

Loan with "Anticipation" or "Advance" or "Payday" in the title — Sure, bad things happen from time to time. However, if you need a loan to make it from one paycheck to the next, or you can't survive until your income tax check arrives, you really need to change your lifestyle. It makes no sense to pay obscene interest rates characteristic of these types of loans to sustain a lifestyle you can't afford.

High Interest Auto Loans — If the only auto loan you can get has a double-digit interest rate, you really should take a long pause and reconsider what you're about to do. A $20,000 car financed for 60 months at 12% will end up costing you almost $27,000 in total payments. That's just crazy. It doesn't matter how much you love the car on the lot, paying an additional 30% for it after interest charges will get old long before the car will.

The perfect financial scenario for most people would be a life free of all debt. Unfortunately, perfect scenarios and real life don't often occupy the same space. Life happens, and consequently, debt happens. The trick is to not make a bad thing worse.

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