The Good, the Bad and the Downright Ugly
By Cindy Diccianni, Financial Advisor
a borrower, nor a lender be," cautions
Shakespeare in Hamlet. The reality is, most
of us carry debt. From a money management standpoint,
that is not necessarily bad. Sometimes debt
is good. Sometimes it's downright ugly. The
key is to carry the right kind of debt, and
not too much of it.
Certified Financial Advisors recommend that
no more than 10 to 15 percent of a person's
take-home pay go to non-mortgage debt; that
is debt that's paid to student loans, car loans,
personal loans, credit cards and so on. Carrying
the right kind of debt is important.
Good debt is generally debt that can provide
a long-term financial payoff. An educational
loan, 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.
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 considered an investment,
as most homes will appreciate in value over
bigger issue is whether homeowners should pay
off their mortgage early if they can. Say you
have a 30-year mortgage and you come into an
inheritance that will allow you to pay it off.
Or you're thinking of paying extra toward the
principal each month, which can dramatically
cut down the total interest you pay. Should
depends. Let's assume you can reasonably expect
to earn a higher return investing the extra
money than the interest rate you're paying on
your mortgage. This is especially significant
if you live in the United States, where the
tax break you get for a mortgage decreases its
real cost to you. If you have an 8 percent mortgage
and you're in the 28 percent income-tax bracket,
you're really only paying 5.76 percent on the
loan. You probably can reasonably invest your
money over time for a higher return than that,
though taxes might eat away some of the difference
unless you put the money into a tax-deductible
the other hand, if you're paying a very high
mortgage rate, paying down your mortgage may
be the better place for your money (consider
refinancing, too). Also, if you live in Canada
or other countries that do not provide tax breaks
for the interest you pay on a mortgage, paying
down your mortgage may be a wise choice.
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, most
cars lose value over time, often quickly.
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.
This tends to be short-term debt 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're still paying for them long
after the vacation is done or the toy is broken.
Also, credit card debt tends to be very expensive-18
percent or more is common.
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, and pay for them in
people would lump credit cards in this category;
it's a toss up. But we've reserved this category
for the really expensive debt that comes from
what's commonly called "fringe banking."
This includes "payday loans," unsolicited
loans in the mail ("take this check and
cash it"), interest on pawned items and
furniture rental (where you end up paying a
lot more than if you'd simply borrowed from
your credit card to buy the TV set). Interest
rates for some of these loans can run 25 percent
to 100 percent or more.
with minimal debt will help create more abundance
in your life and is critical to financial success.
As a rough rule of thumb, many advisors recommend
that people aggressively pay down any debt whose
interest rate runs 10 percent or more. For rates
lower than that, you'll have to evaluate whether
to pay off the debt, use the money for investments
or place the money in an emergency fund. When
in doubt, check with your financial advisor.
Diccianni is a Registered Nurse,
a Certified Senior Advisor (CSA), a Registered
Investment Advisor and a Registered Representative
with Leigh Baldwin & Company member NASD
and SIPC. She is affiliated with Ortner, O'Brien
& Ortner Advisory Group, Inc. and co-founder
of Nurturing Your Success, Inc. Her passion
is assisting clients in creating financial freedom.
You may visit Cindy at www.nurturingyoursuccess.com,
write to her at Cindy@nurturingyoursuccess.com
or call her directly at (610) 251-9393.