The Good, the Bad, and the Downright Ugly - debt management - Brief Article

USA Today (Society for the Advancement of Education), August, 2000

Most people carry debt. From a money management standpoint, that is not necessarily bad. Sometimes, debt is good. Sometimes, it is downright ugly. The key is to carry the right kind of debt, and not too much of it.

According to the Financial Planning Association, Denver, Colo., most certified financial planners recommend that no more than 10-15% of a person's take-home pay go to nonmortgage debt. That is debt paid to student, car, and/or personal loans; credit cards; etc. Just as important is carrying the right kind of debt.

Good debt generally is debt that can provide a long-term financial payoff. Educational loans--either for your children or perhaps career education for yourself--is a good example. The improved earning power from the education should more than pay back the cost of the loan.

Mortgage debt is another "good" debt. To begin with, few consumers can afford to pay cash for a home. Also, a mortgage is good debt in the sense that a home is an investment: most homes appreciate in value over time.

There is such a thing as too much good debt. Busting your budget by buying the most expensive home you can possibly afford or a high-end sports car to get to work generally isn't financially wise.

Bad debt tends to be short-term in which the loan lasts longer than the item you bought with the debt and for which there is no financial payback. Most credit card debt falls into this category. People pay for everything from dinner to toys to clothing to vacations on their credit card and they still are paying for them long after the vacation is done or the toy is broken. Also, credit card debt tends to be very expensive--18% or higher in interest charges is common. Loans for furniture, appliances, cars, and other personal needs also can be fairly expensive, though usually not as high as credit cards. Save for these items whenever possible.

Car loans could fit into the good or bad debt category. Borrowing to buy a car that you need to get to work is usually justified. However, unlike most homes, cars tend to lose value over time, often quickly.

Ugly debt is the really expensive debt that comes from what is commonly called "fringe banking." This includes "payday loans"; unsolicited loans in the mail ("take this check and cash it"); and interest on pawned items and furniture rental, where you end up paying a lot more than if you had simply borrowed from your credit card to buy the TV set. Interest rates for some of these loans can run 25-100% or more. As a rough rule of thumb, many planners recommend that people aggressively pay down any debt with an interest rate of 10% or more.