Quantcast
Channel: DailyFinance.com
Viewing all articles
Browse latest Browse all 9760

When Is There Such a Thing as Good Debt?

0
0

Filed under: , , , ,

Debt education
HG Delaney/Alamy

Most of the time, the word "debt" has negative connotations. Debt costs you money -- thanks to interest rates -- and therefore takes money away from financial goals like saving and investing. And the stress of carrying and repaying debt can take a serious toll on your health and relationships.

So could there ever be good debt? There's no hard-and-fast answer. That's because how you use debt has a big impact on whether or not you can consider it "good." And you can have too much of a "good" thing -- and that's when it can turn into bad debt.

Yes, you can use debt as a tool. Debt can provide leverage and create opportunities for you to improve your financial situation if you use it wisely. However, it's important to do a cost benefit analysis. Let's consider three types of debt: investing in a college education, buying a home or starting a business.

1. Are Student Loans Always Good Debt?

After working with tons of millennials across the country, I don't think that student loans are always good debt. I've seen quite a few people with high interest rates on private student loans, and I caution you against taking out private student loans for any reason.

I don't think that many people consider how long they'll be paying back their student loans when they take them out.

Another warning: I think that when your student loans cross six figures, you better be making at least six figures for a very long time if you want to pay those off. While I believe that an undergraduate college degree is a baseline for most jobs, I've seen too many people with student loan debt so high you'd think they went to law school when really it was from an undergraduate degree from a private liberal arts college.

I don't think that many people consider how long they'll be paying back their student loans when they take them out. You could be in debt for the next 30 years, and this will have a dramatic effect on the type of job you can take when you graduate. A student loan calculator will help estimate your monthly payments once you graduate.

Student loans aren't necessarily bad. If you take them out to obtain a high-paying job that you could have only secured with a college education and earn enough to make your student loan repayments manageable, your student loan debt was good debt. Here are a few rules of thumb:
  • Keep your total loans under your projected starting salary when you graduate. If you're able to do that, you should be able to pay them off with the standard 10-year plan.
  • Cut down on the loan amount. Get college credits while you're in high school, go to a community college for your first two years, stick to a state school and apply for scholarships.
  • Get a job to pay for your living expenses while you're in school so you don't take out loans for living expenses.
  • Stay away from private student loans because they don't offer the flexibility of federal loans.

2. How Much Should I Borrow for a Mortgage?

Owning a home used to be considered the American dream, and for many people it still is. Most people need to take out a mortgage for their purchase. If you think you'll be in the same area for several years and can put a 20 percent down payment on a home, a mortgage could be a good long-term investment. Interest rates on mortgages are historically very low, and owning a home can also provide tax benefits. The nice thing about a home is that it's an investment you can live in.

However, I've seen a lot of people who are house-poor. People get so caught up in the whirlwind of buying a home that they spent more than they planned without realizing how this would affect their lifestyle or how they'll pay the mortgage if an emergency came up. Here are a few rules of thumb:

  • Make a 20 percent down payment so you can avoid paying private mortgage insurance.
  • Don't use your entire savings account for a down payment. Homes are a hotbed for dipping into your emergency savings. There are far more unexpected expenses that come up than when you're living in an apartment.
  • Boost your credit score before you buy. Make sure you have a score above 700 so you can qualify for the best mortgage rates available. This will save you thousands of dollars in interest over the life of the loan.
  • If you think you might move in the next five years, you might want to rent so you don't have to move during a down market and possibly sell your home for a loss.
  • In figuring out your monthly housing costs, the principal and interest on the mortgage loom large. But don't forget property taxes, insurance, utilities, repairs, landscaping, snow removal and other factors. Make sure that your monthly housing expenses leave room for other expenses so that you're not house-poor.

3. What About Using a Loan to Start a New Business?

I believe that entrepreneurship is the new job security for Gen Y. Incurring debt to start a business can be good debt if the funds help you to build a sustainable livelihood that allows you to repay any money borrowed and improve your financial situation. Just be cautious of how much debt you're taking on. Here are a few rules of thumb:

  • Self-fund your business venture with savings first. (I launched my own financial planning company with less than $10,000).
  • The smaller the investment, the quicker you can make money. It's much easier to start a business with less than $1,000 than ever before. Things like freelance writing, Web design and consulting are easy-to-launch side-hustles that can become full-time gigs.
  • Do your research and get experience in the field before your launch. Some business opportunities require much bigger up-front investments, which may lead to a small business loan. However, before you start your own restaurant with $100,000 investment, know that the success rate of new restaurants is extremely low.

Debt Costs Money: Use it Wisely

Debt can be good, but only if it helps you leverage your assets to build wealth. Every good debt has the potential to turn bad, so do your research and due diligence. Remember, it costs money to borrow money so be mindful of the interest rate on your loans and pay extra to pay off your debt faster. The fewer monthly obligations you have, the more money you have to fund a lifestyle that you love.

Sophia Bera is a virtual financial planner for millennials and the founder of Gen Y Planning. She is location-independent but calls Minneapolis "home." Do you want to be better with your money than 90 percent of your friends? Sign up for the free Gen Y Planning newsletter.

 

Permalink | Email this | Linking Blogs | Comments


Viewing all articles
Browse latest Browse all 9760

Latest Images

Trending Articles





Latest Images