According to the Federal Reserve, at the end of the fourth quarter of 2013, U.S. household borrowing jumped by nearly $241 billion.
For some financial pundits, the increase in debt was considered a signal that the consumer is coming back and the economic momentum is improving. For other financial prognosticators, the return to quarterly household debt increases is a sign that much of the financial crisis has been forgotten.
Kyle Jones, Financial Planner at Wamhoff Financial Planning & Accounting Services, discusses the good and the bad of debt with Elliot Weiler.
1. Mortgage Debt:
- The primary driver of the increase in household indebtedness was mortgage debt.
- The good news about mortgage debt is that home ownership is one of the building blocks to creating wealth. Interest is partially tax deductible, and over time, equity increases which builds net worth.
- The bad news is that too much mortgage debt (typically anything more than 33% of monthly after-tax income) can jeopardize long term fiscal stability. Also, most of the mortgage payment made in the early years goes to interest, so it takes a while to really make a debt in principal.
- The bottom line – be wise and realistic about how much you can afford. Save for a down payment, and make a backup plan for how you’ll make payments if you experience a loss of income.
2. Other Forms of Debt that Can Be Positive:
- Some debt, such as rental properties, farm land, or raw land for long term appreciation, can produce cash flow.
- Home Equity Lines of Credit can be used to help reduce high interest debt, or used for a purchase such as a car in order to allow for deductions.
- 0% interest or same-as-cash offers can be positive when used sparingly and only when debt incurred can be paid off in the allotted period of time.
3. The Many Forms of Bad Debt:
- Credit card debt is a killer for most American families – not only due to the high interest rates, but because large debt levels also create forward cash flow issues.
- Credit card debt is the single largest negative factor that reduces the prosperity of so many people.
- Debt incurred for vacations or large purchases like electronics or other high dollar material items which carry large interest rates. These are bad for cash flow and long term fiscal growth at the household level.
- The types of debt listed above creates a large number of payments required each month, which drains free cash flow and hinders the ability to make good financial decisions.
- Avoid this by saving for vacations and large purchases. If you do put these expenses on a credit card, create a realistic plan for paying it off as quickly as possible.