American household debt – including mortgages, auto and student loans, and credit cards – has reached a new high at $12.7 trillion, surpassing the previous peak credit bubble levels of 2008, according to the Federal Reserve Bank of New York. In today’s low interest rate environment, debt can be beneficial to many consumers. When considering whether to take on debt, you should evaluate your financial situation, weigh the tradeoffs, and determine what level of debt you can realistically maintain. In this article, we outline four common types of debt and key considerations for each.
Mortgage
Mortgage debt, which makes up the largest percentage of all consumer debt, provides the most financial benefits to consumers. For example, home ownership can help build personal wealth and financial stability, while annual tax deductions are generally available for those with qualifying mortgage interest expenses. With interest rates still hovering near all time lows, taking on mortgage debt today may be a more attractive option, particularly over the long-term, than paying with cash or taking a large withdrawal from an investment portfolio.
Student Loans
Another type of debt with potential financial benefits is student loan debt, which is the fastest growing portion of all consumer debt. Similar to mortgage debt, there are tax deductions for qualifying student loan interest and tuition expenses. However, unlike mortgage debt, student loans cannot typically be restructured or shed in bankruptcy. Beyond these tax incentives, higher education is positively correlated to future income potential and employment opportunities.
Auto Loans
In contrast to mortgages and student loan debt, auto loans and credit card debt typically fall into the “bad debt” category. What is bad debt? Bad debt includes purchases made on depreciating assets, or assets that typically do not generate income or increase in value once purchased. While auto loan rates are still relatively low, these loans should be weighed against other options (i.e., leasing). Likewise, since these loans do not provide tax benefits, consider looking for auto loans with little to no interest and pay it off as quickly as possible. That way, as the vehicle depreciates and maintenance increases, you will not be stuck with on-going payments.
Credit Cards
Finally, credit card debt should be minimized whenever possible. Credit card companies charge extremely high interest rates, and have payment schedules designed to keep costs high for consumers. However, when used strategically, credit cards are a good way to build positive credit history and provide card holders with incentives. As long as you can pay the balance off monthly, during the grace period when no interest is accrued, credit card reward programs can be a beneficial way to earn extra incentives on purchases you would typically make.
Debt, like mortgages and student loans, can actually be beneficial to consumers, while credit card debt and auto loans may harm overall consumer health. With consumer debt reaching an all-time high, it’s important to take the different types of debt into consideration and look at your overall financial goals, especially in today’s low interest rate environment.
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