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How Do We Manage Debt In Our Financial Plan?


For many people, debt is a fact of life. You may have first encountered debt when you applied for your first credit card, took out a student loan, or bought (and financed) furniture for your shoebox-sized apartment when you got your first job.  

Like most people, you probably have mixed feelings about the debt load you carry. That’s because, while no debt is truly “good” there are some forms of debt that can help to improve your financial standing. Alternatively, many people hurt themselves financially by taking on “bad” debt – which is labeled as such as it doesn’t improve your situation by taking it on, or the terms of the debt were not ideal. 


The Good, The Bad, and The Ugly 

When viewed from a financial planning perspective, there is good debt and there is bad debt. Your goal should be to purge the bad debt that’s negatively impacting you, and effectively manage the good debt, with the goal of becoming debt-free.  

But what’s the difference between “good” and “bad” debt? And is any debt ever truly “good”?  

In short, no. In a perfect world, you would be able to move through life debt free and use your money to purchase what you need. The you could invest, save, and grow your wealth. But for almost everyone, that isn’t a reality (how many people save up 100% of the purchase price of a house?). However, it’s widely accepted that some debts aren’t as negative as others.  

Generally, debt used to purchase appreciating assets can be considered good debt. Expenses that qualify as “good” debt might include: 

  • A house 
  • An investment property 
  • Higher education (to some degree) 

The value of your house can appreciate over time, which can contribute to your wealth; and the interest on your mortgage is tax deductible (up to certain limits). So, in that regard, mortgage debt could be considered “good debt.” The same could be said for an investment property (which is not only going to appreciate over time but might further contribute to your wealth if you rent it out as a source of income). 

Student loans are also considered “good” debt by many. This is because, like a house, your college education should ideally appreciate in value with time. With a college degree, you’re more likely to get a high paying job in an elite field. As you progress in your career, your salary will continue to increase, effectively increasing your value (and the value of the degree you paid to earn) as an employee.  

Additionally, up to $2,500 of interest paid on student loans, is tax deductible within certain income limits. While this doesn’t necessarily add to the “good” debt argument, it certainly makes the idea of a student loan more attractive than other debts available. 

However, these so-called “good” debts can become bad over time. A few key indicators that your debt has gone from good to bad to downright ugly are: 

  • You can no longer keep up with payments 
  • You start to feel negatively about your debt 
  • Your debt is holding you back from achieving other important financial goals and milestones 
  • You’ve overspent on “good debt” items – and are now suffering from lifestyle inflation 

When it comes to purchasing a house or a college education, it’s important to try and stay within your means. For buying a house or investment property, there’s always a temptation to buy a bigger or better house than you can afford. The same is true for college educations. Many people feel that a degree from an expensive, private university will show better than a less expensive degree from an in-state college.  

The question you must ask yourself before making these spending decisions is: will I be able to live with the debt I’m taking on? This means looking at potential repayment plans, and how your debt fits into your big-picture financial goals.  


Bad Debt is an Indication of a Spending Problem 

When debt is used to buy things that depreciate – it should be considered bad debt. At the risk of oversimplifying things, bad debt is used to buy things you can’t really afford.  

After all, if you could afford it, you should be paying for it with cash.  

A few examples of “bad” debt are: 

  • Credit card balances that are carried through more than one billing cycle 
  • Auto loans 
  • Financing plans for everyday items 

This is where things often get confusing. People view some big purchases as an asset – like a vehicle. However, while having a car for transportation is essential and it’s a valuable asset, it immediately starts depreciating in value the moment you drive it off the lot. It’s especially problematic when you purchase a vehicle that’s “more car” than you can afford – and are making unnecessarily high payments each month to pay down your loan.  

When you purchase a vehicle with little or no equity in your car and a five to seven-year payment term, you’ll owe more on the car than it’s worth for several years. If you try to trade it in for another car after three or four years, you’ll still owe a balance to the lender. And, rolling the balance into a new car loan when you want to switch just exacerbates the problem.  

The goal for cars should be to put at least 50% down, have a short-term loan, and aim for a 0% interest rate. Ideally, you should be paying for your car in cash when it’s possible. That might mean saving for an extended period of time or purchasing a used vehicle. 

 

Focus on Buying What You Can Afford 

Keep in mind, bad debt isn’t only limited to car purchases. If you must use credit to buy groceries and other essentials, and you keep the balance of this purchase past one billing cycle, it means you are overspending in other areas – and creating a debt problem for yourself.  

To avoid this problem, focus on buying only what you can afford. If you’ve been living in a debt cycle, this might not be an easy transition. However, as you pay down your existing debt and free up cash flow, you’ll find that it becomes easier to save for things on your “to buy” list. Saving for your goals also helps you to spend intentionally, and you’ll be less likely to make a purchase that’s above and beyond what you can afford.  

 

Your Bad Debt is Costing You More Than You Think 

While your goal should be to eliminate all bad debt, you should first target your high interest debt. This is usually a credit card with an outstanding balance, or a high-interest car loan. The interest costs you pay on any bad debt isn’t just an expense – it’s a lost opportunity to have that money working for you.  

Carrying debt can have a negative psychological impact, as well – especially for those who need the money they spend each month that goes to paying down debt. Retirees often fall under this umbrella. Your debt may feel like a constant reminder of a mistake purchase, of living beyond your means, or for failing to plan for your future.  

It’s important to remember that if you’re feeling this way, you aren’t alone. Many Americans carry a debt load that’s a mix of both good and bad debt. Some even carry it into their retirement years. Luckily, you have total control over your debt – not the other way around. With a disciplined budget and a financial plan focused on long-term goals, you can pay off your debt quickly while still focusing on growing your wealth.  

Remember: money is just a tool for you to use. Even if debt has had a negative hold on your financial life up until now, you have the power to change the narrative. It’s never too late to evaluate your debt and prioritize repayment.