What If Everything You Thought About “Good” and “Bad” Debt Is Wrong?
Most people have been taught that certain kinds of debt are “good,” and that others are “bad.” But these days, debt doesn’t necessarily fit into neat categories. While years ago, people might have stuck with the same job for the long haul (and in fact, more than 40% of Baby Boomers stayed with their employer for 20+ years), today’s economy is much more fluid, with millennials more willing to act on job opportunities and move from company to company. So all that old school financial advice? It doesn’t apply so much anymore.
Take a look at some of the biggest misconceptions about good debt vs. bad debt, and use the facts to get a better handle on your finances. You can consider this your personal debt payoff planner.
Good debt misconceptions
Myth: Putting a 20% down payment on a mortgage is always a wise move.
Fact: Buying a house can be a good investment, especially if the value of your home outpaces inflation. But while there are advantages to putting 20% down on a mortgage, saving that much dough isn’t always easy. Putting less down allows you to tackle important short-term goals like paying off student loan debt, and make headway on long-term goals such as saving for retirement. Consider this: The average down payment on a single-family home in the first quarter of 2015 was 14.8%, so that guideline is changing. (And with SoFi, you can purchase a home far below that average with just 10% down.)
Tip: Get your mortgage rate in just two minutes. If you already have a mortgage, refinance for a lower rate. You might be surprised how much you can save. The average interest rate for a 30-year fixed rate mortgage was 4.726% in September 2013, and just three years later it fell to 3.579%. Refinancing with a lower rate could replace a 30-year loan with a 15-year loan, and hardly change your monthly payment amount.
Myth: High-interest student loans are a fact of life.
Fact: Yes, student loans allow you to get the education you need to secure the career you want, but that doesn’t mean you have to stick with the terms you were initially given. After you graduate, you can refinance your student loan to secure a lower interest rate and save money over the life of the loan.
Myth: Student loans take at least 10 to 20 years to pay off.
Fact: With a little discipline, you can pay off your student loans before you’re old and gray. In addition to refinancing for a lower rate, you always have the option to pay more than the minimum due. It’s amazing how quickly an extra $50 or $100 toward the principal adds up!
Another way to prepay student loans (or pay more than the minimum) is to schedule bi-weekly payments instead of monthly. By making one extra month of payments each year, you’ll chip away at your student loan that much quicker.
Bad debt misconceptions
Myth: Credit cards are nothing but trouble.
Fact: Credit cards aren’t inherently good or bad; it’s how you use them that determines their harm or value. Using credit for purchases that you pay off in full each month is smart because that diligence boosts your credit score. (On the flip side, never carrying a credit card balance means no payment history or late payments, which may hurt your score.) Plus, plenty of credit cards offer rewards, such as discounted travel, purchase and fraud protection, and cash back on purchases.
Looking for the optimum amount to charge? Here’s a good rule of thumb: Keep your debt ratio below 30% of your credit limit. So if the limit on your credit card is $10,000, you should charge less than $3,000 each month. And be sure to pay off that full amount each month as well. But if you ran up your card for a trip, and you’re struggling to make the monthly payments, there’s still hope: You can use a personal loan that offers a lower interest rate and a fixed monthly payment to pay off that credit card debt.
Myth: Getting a personal loan for a home renovation is a bad idea.
Fact: A personal loan can be your best friend when you need funds for home renovation and decoration. Contrary to what you might have heard, getting a personal loan for this purpose is far from frivolous—investing in the layout and design of your home can increase its resale value, putting money back in your pocket.
For homeowners who have built up significant equity in their home and are planning a major renovation, a home equity loan is another financing option. If you owe $200,000 on a home valued at $500,000, for instance, you can apply for a home equity loan of $300,000. But for newer homeowners with little equity in their home, or those interested in smaller projects like a one-room remodel, a personal loan is a better choice.
Either way, you don’t want to spend more than you can afford. To keep your home renovation on budget, work with professionals who will help you develop a plan of action and advise you on costs. Just make sure you hire pros whose projects fall within the range you want to spend.
Myth: Auto loans are a waste of money.
Fact: Not necessarily. Only you can determine which expenses make sense for your budget and lifestyle. In 2016, the average monthly payment for a new car loan was $495, with a loan term of 68 months ($33,660 total). That’s not exactly spare change. There are ways to keep costs down, however.
If you buy an electric car, you’ll save money on gas ($1,267.50 each year) and say goodbye to oil changes forever. And don’t forget to factor in the tax credit from the federal government (up to $7,500) and possibly even your state. Use that extra cash to pay down your car loan quicker and save on interest.
A new era of debt and solutions
Today, debt is more personal than the good debt vs. bad debt debate would have you believe. Rather than trying to classify your debt, consider the interest rates of each loan. Maybe you scored an auto loan with a low interest rate, but got stuck with a mortgage with a sky-high one. Securing a lower interest rate is a key part of any debt payoff plan, helping you transform “bad” debt to “good.”
Also, consider the value that things like education, a home, and travel add to your life. Education can open doors to a more lucrative and fulfilling career, your home can be an investment, and travel can provide the joy of exploring new corners of the world. Spend time thinking about your situation and determining your specific financial, career, and relationship goals. Then, based on those goals, develop a debt payoff plan that makes the most sense for you.
To learn more about managing your debt, contact a SoFi Wealth Management advisor. In the meantime, share this article with someone you know who is struggling with debt—good, bad, or anything in between.