No matter whether it’s high-interest credit card debt or so-called good debt such as student loans or mortgages, carrying more debt than you can afford can seriously hamper your life and finances.
According to the Federal Reserve in January 2019, excessive student loan debt has prevented young people from buying homes. The Federal Reserve looked at homeownership rates between 2005 and 2014 and found that rising student debt levels during that period likely caused homeownership rates among 24- to 32-year-olds to drop by 2 percentage points.
Meanwhile, a November 2018 survey from Summer — which is dedicated to helping student loan borrowers — and Student Debt Crisis found that many recent grads are putting off other life goals, too, such as starting a family or business.
Not only can too much debt force you to put parts of your life on hold, it can wreck your credit score. If your balances grow so high that you can’t afford to pay even the minimum amount due, you could begin collecting delinquencies (late payments by 30 days or more) on your credit reports. That is a major red flag to lenders.
But not all debt is necessarily worth avoiding. As long as you limit what you borrow and routinely pay your bills on time, a reasonably priced loan can often help you get things you couldn’t afford otherwise, such as a higher education, a reliable car, a quality computer or a home you can call your own.
What makes debt good or bad?
According to credit expert Beverly Harzog, determining whether a loan is good or bad largely comes down to how affordable it is and how you use it.
“A lot of people don’t understand that not all debt is bad,” Harzog said. Some loans can help you build credit so that you can afford lower-priced loans in the future. Others help you invest in assets — or in yourself — so that you can start to build wealth at a younger age.
If you’re considering taking out a loan and know that you can’t pay it off immediately, you may want to first ask yourself:
- Is this loan helping me reach an important goal?
- Am I paying a fair and affordable interest rate?
- Can I pay off this loan within a reasonable time period?
- Will I have to make major trade-offs in my life to repay this loan? (And am I OK with that?)
4 types of good debt
It’s not always possible to go through life without ever paying interest. There are times when debt is worth the extra cost.
These are some of the types of loans that many experts consider to be good debt:
- Loans that help you reach a personal goal. If you’re trying to improve yourself and your life circumstances but don’t have the cash to finance your venture upfront, a loan can help — as long as you borrow within reason. For example, financing your education would be considered a worthwhile reason to borrow, said Bruce McClary, vice president of communications at the National Foundation for Credit Counseling. “There are certain types of debt that are more like investments in your future, like a student loan that helps you obtain a degree and that allows you to increase your future earning potential,” he said.
- Loans that help you build wealth. Some loans can help you earn more money over time by allowing you to purchase an asset upfront and reap the benefits later if that purchase grows in value. A home loan would be considered an investment, McClary said. “You are making payments toward ownership of property,” he said. “As you own that property, the hope is that it will increase in value and build equity.”
- Loans that help you purchase an essential need. A loan can help you finance purchases that you need but can’t afford to pay in cash, such as a reliable car you can drive to work or a new furnace or refrigerator.
- Loans that help you save money. Some loans can help you shave your overall costs, Harzog said. If you have good credit and use a low-rate personal loan to pay off your debt, that loan would be considered a net positive, she said. Similarly, a credit-builder loan can help you improve your credit score and save money on interest.
4 types of bad debt
Debt becomes harmful when it starts to hold you back in life rather than help you move forward. For example:
- Loans that cost you a substantial amount of interest. If you have a large balance and are being charged a double-digit APR, that would be considered bad debt that you want to pay off quickly. For example, payday loans charge notoriously high APRs. “Carrying a balance and paying interest, this is just toxic debt,” Harzog said. “Your balance can just grow so quickly.”
- Loans that prevent you from achieving your goals. If your debt is holding you back in life — by making it difficult to save for retirement, buy a home or invest in yourself in other ways — that debt would also be considered bad debt. That’s why some debt that’s traditionally considered good debt, such as student debt or a large mortgage, can turn toxic if you borrow too much of it.
- Loans that can be difficult to pay off. Some loans are so expensive that they are notoriously hard to get rid of once you’ve taken them out. Payday loans, for example, often come with APRs near 400%. “This can drag people into a terrible debt cycle,” Harzog said. Some people, for example, wind up taking out additional payday loans just to cover the expenses they incurred with their last one, she noted. “It can get out of control in a hurry,” she said.
- Debt that costs you money with little in return. Spending money on interest when you don’t have to can be harmful. If you revolve a balance on your credit card when you can comfortably afford to pay off your balance in full, you are throwing money away for no good reason.
What to do when you have bad debt
If you have a lot of toxic debt, you should work to pay it off as soon as possible:
- Continue to pay at least the minimum amount due on every loan since you’ll have more options if you have good credit. Then, map out a plan to shrink your debt.
- A balance transfer card with a lengthy 0% promotional period or a personal loan with a lower interest rate can help you consolidate your debt and pay it off more quickly.
- You may be able to lower your interest payments or work out a sustainable repayment plan by contacting your lender. “Negotiate with your creditors,” McClary said. “If you feel that your progress toward paying off debt is stymied by paying a higher interest rate than you deserve, it’s on you to make the first move.”
Finally, don’t forget to think back on how you accumulated so much debt in the first place, Harzog said. “Sometimes it’s an emotional issue,” she said. If you’re overspending because you feel anxious or you get a feel-good boost each time you charge your card, it’s important to work through those issues before you return to borrowing. That way, “once you’re out of debt, you can stay debt-free,” Harzog said.
Interested in a personal loan?Here are the top personal loan lenders of 2019!
|Lender||APR Range||Loan Amount|
|1 Includes AutoPay discount. Important Disclosures for SoFi.
2 Includes AutoPay discount. Important Disclosures for Payoff.
3 Important Disclosures for FreedomPlus.
4 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
5 Important Disclosures for LendingPoint.
6 Important Disclosures for LendingClub.
All loans made by WebBank, Member FDIC. Your actual rate depends upon credit score, loan amount, loan term, and credit usage & history. The APR ranges from 6.95% to 35.89%*. The origination fee ranges from 1% to 6% of the original principal balance and is deducted from your loan proceeds. For example, you could receive a loan of $6,000 with an interest rate of 7.99% and a 5.00% origination fee of $300 for an APR of 11.51%. In this example, you will receive $5,700 and will make 36 monthly payments of $187.99. The total amount repayable will be $6,767.64. Your APR will be determined based on your credit at the time of application. The average origination fee is 5.49% as of Q1 2017. In Georgia, the minimum loan amount is $3,025. In Massachusetts, the minimum loan amount is $6,025 if your APR is greater than 12%. There is no down payment and there is never a prepayment penalty. Closing of your loan is contingent upon your agreement of all the required agreements and disclosures on the www.lendingclub.com website. All loans via LendingClub have a minimum repayment term of 36 months. Borrower must be a U.S. citizen, permanent resident or be in the United States on a valid long term visa and at least 18 years old. Valid bank account and Social Security number are required. Equal Housing Lender. All loans are subject to credit approval. LendingClub’s physical address is: LendingClub, 71 Stevenson Street, Suite 1000, San Francisco, CA 94105.
†Per reviews collected and authenticated by Bazaarvoice in compliance with the Bazaarvoice Authentication Requirements, supported by anti-fraud technology and human analysis. All reviews can be reviewed at reviews.lendingclub.com
**Based on approximately 60% of borrowers who received offers through LendingClub’s marketing partners between January 1, 2018 to July 20,2018. The time it will take to fund your loan may vary.
7 Important Disclosures for Earnest.
8 Important Disclosures for Avant.
* The actual rate and loan amount that a customer qualifies for may vary based on credit determination and other factors. Funds are generally deposited via ACH for delivery next business day if approved by 4:30pm CT Monday-Friday. Avant branded credit products are issued by WebBank, member FDIC.
** Example: A $5,700 loan with an administration fee of 4.75% and an amount financed of $5,429.25, repayable in 36 monthly installments, would have an APR of 29.95% and monthly payments of $230.33
* Important Disclosures for Upgrade Bank.
Upgrade Bank Disclosures
** Accept your loan offer and your funds will be sent to your bank via ACH within one (1) business day of clearing necessary verifications. Availability of the funds is dependent on how quickly your bank processes this transaction. From the time of approval, funds should be available within four (4) business days.
|5.74% – 16.99%1||$5,000 - $100,000|
|7.54% – 35.99%||$1,000 - $50,000|
|7.99% – 35.89%*||$1,000 - $50,000|
|5.99% – 24.99%2||$5,000 - $35,000|
|5.99% – 29.99%3||$7,500 - $40,000|
|6.79% – 20.89%4||$5,000 - $50,000|
|9.99% – 35.99%5||$2,000 - $25,000|
|6.95% – 35.89%6||$1,000 - $40,000|
|6.99% – 18.24%7||$5,000 - $75,000|
|9.95% – 35.99%8||$2,000 - $35,000|