The new year is off and running, and spring has officially sprung. That can mean only one thing – spring cleaning time is upon us. While I can’t help with your garage or closets, I can help you organize your finances. More specifically, your debt.
While many Americans have proven to be quite adept at borrowing, as we saw from the financial crisis, paying it back is a bit trickier. And, failing to pay off your debts can have a devastating and lasting impact on your personal finances.
This begs the question; how should one use debt, and is there good debt or bad debt? The answer, of course, is yes, or this article would be relatively short.
Debt can be evaluated based on repayment terms, interest rates, and return on investment. It is also important to note the recourse if you can’t pay off the debt, i.e., seizure, liens, bankruptcy, etc.; however, that particular consideration is the worst-case scenario and beyond the scope of this discussion. Let’s compare what makes debt good or bad by way of examples.
Student loans have taken center stage in the public debate recently due to their ever-growing balances. However, the reality is that loans for education tend to be good debt because those loans, presumably, enable you to enhance a lifetime of earnings. The exception would be borrowing exorbitant amounts or borrowing to attend schools or pursue majors that historically don’t pan out.
According to Business Insider, the average graduate in Florida for the class of 2016 had just under $13,000 of student loan debt. I would submit to you that over your lifetime of earnings uplift compared to a high school diploma, $13,000 is well worth the investment. To recap, an investment in education can often be financed with flexible repayment terms, a decent but not great interest rate, and, most importantly, a strong return on investment.
To illustrate the opposite end of the spectrum, let’s use a completely frivolous but frequently used debt financing strategy, a big-screen television. When the big-box retailer finances you the television, it is often on a credit card. Some offer no interest, but when you miss a payment or can’t pay it all off on time, all that interest comes roaring back, and it is often at a double-digit rate.
In addition, there is unlikely to be any return on investment. The very nature of technology renders that television obsolete the moment you get it out of the box. From day one you owe more on that credit card then you have to show for it in the asset you just purchased. To recap, an investment in a consumer goods, e.g. a television, often accompany poor repayment terms, high interest, and little to no return on investment.
Debt is not inherently bad. The responsible use of debt can maximize returns on investment and make a great many things possible. The downside is that it can be difficult to exercise self-control, and companies make the most dangerous types of debt readily accessible. Avoid buying consumer products with debt if you can’t afford to pay it off immediately. If you have a lot of debt, clean it up by paying off the highest interest rates first and borrow responsibly moving forward.
This article is meant to be general in nature and is not intended, and should not be construed as personal financial advice. Please consult your financial advisor prior to making financial decisions. Gary Parsons is a Financial Advisor with U-Vest Financial®, a separate entity from Waddell & Reed and can be reached at 850.300.7055. Waddell & Reed, Inc., Member SIPC. (03/21)