Buying a new house, nicer car, maybe a boat or even a lake home is something a lot of people look forward to as they progress in their career and make a higher income, but the financing side of it can be all consuming. There are many programs and methodologies out there that talk about reducing and eliminating debt, so why do some people say that debt is a good thing?
Debt comes in all different shapes and sizes, and it isn’t always created equal. When we talk about lowering debt, we’re often referring to high interest rate debt that can quickly spiral out of control. Credit cards specifically often have double digit interest rates, ranging from 15% all the way up to 25% or higher. When this kind of debt accumulates, the interest rate is so high, that not only are you making extra payments on this interest but any extra income you have that might be invested likely wouldn’t earn over and above the interest rate of a credit card on a consistent basis. That’s why this type of debt is considered “Bad Debt” and should be paid off as quickly as possible. There are many debt paydown strategies, such as the Avalanche or Snowball method and they both focus on different ways lower these high interest liabilities and how to use extra cash flow to do so.
But you might be thinking to yourself, well I don’t have credit card debt, but I do have a mortgage and I do have an auto loan…. Should I be making extra payments on these each month? And the answer to this is, it depends. What’s the interest rate on the mortgage right now? Is it 3%? If so, could you reasonably earn more than 3% if you invested your extra income in the market? Sometimes for these low interest liabilities it makes sense to make the monthly payments, but simply to chip away at it over time rather than paying it off as quickly as possible.
Any money left over would then be invested in the market with the hopes of earning a higher return than your interest rate on the loan. This might be on property that you own or it could be a line of credit with a low interest rate or even a business loan. “Good Debt” refers to debt where your return on investment is higher than the interest rate would be.
Debit is a part of life, and whether we’re talking about good debt or bad debt, you should absolutely be making the monthly payments on the bills that you have, at a bare minimum. For certain types of debt it might make sense to pay them off slowly, for others, we need to get rid of it faster. The important thing to understand is that everyone views debt differently. For example, it might make sense to keep your mortgage in retirement, but if that’s going to worry you and keep you up at night, that’s not a recommendation that would make sense for your situation. It’s important to look at the type of debt that you have, what your other investments are doing, and what your relationship with money is when making these paydown strategies, and that’s where a wealth advisor comes into play. To understand more about your debt, talk to your wealth advisor and create a strategy that works well for you.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.