I feel like I’m going all “Dave Ramsey” on you people, but debts are serious business. Debts put us into a position of weakness by owing money that we currently do not have. While there are legit reasons to take on debt, the majority of Americans accept these financial weaknesses too freely.
Debts are big business in the United States, and they bury too many Americans underneath mountains of stress that are tough to escape from. Some frightening numbers, from nerdwallet.com:
U.S. Consumer Debt
|By Household||Total debt owed|
|Credit cards||$15,675||$729 billion|
|Auto loans||$27,865||$1.1 trillion|
|Student loans||$48,591||$1.26 trillion|
|Any type of debt||$132,158||$12.29 trillion|
These numbers are startling, and I do not believe “good debt” exists. I do accept that some debts – like student loans for the right degree, can improve our financial position over the long run. But, we Americans also need to be keenly aware of exactly what we’re doing and understand the gravity of our choices before debts can turn into a positive.
The $729,000,000,000 of credit card debt that murders the futures of Americans is an unfortunate indicator that we don’t know what we’re doing. Debts are easy. The cheap availability of credit in the United States is killing American retirement.
It’s out of control, and our collective willingness to accept the financial burdens of debt is devastating. We accept debts as a natural part of life, and that’s the wrong attitude. They don’t have to be natural.
To this humble little personal finance blogger, only two GOOD reasons exist to take on more debt – and by “debt”, I’m talking about debts that can turn positive, like student loans and mortgages. If your situation doesn’t fall within these two categories, it’s probably not a good idea.
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The two reasons to take on more debt
1: You’re in good financial standing
Those who are in good financial standing can “afford” debt. They have a good, steady job and earn quite a bit more than the anticipated monthly payment to repay the debt.
They currently have no debts – or very little. If they lose their jobs suddenly, they can afford to keep paying their monthly payments for several months.
They have an emergency fund with at least three months of living expenses.
They don’t live paycheck to paycheck and have a proven track record of paying monthly bills on-time. Automatic monthly payments are even better.
They regularly spend less than they earn.
How much debt to accept: If we are talking about mortgage debt, conservatively, do not take on a mortgage payment of more than 30% of your take-home pay. Take-home pay means after taxes. If you’re willing to accept more risk, then don’t let your mortgage payment exceed 30% of your pre-tax pay.
For student loans, don’t take on debt to attend an out-of-state school! All accredited universities in the United States – yes, including your state school(s), provide fine educations to get your foot in the door in corporate America. Don’t kid yourself into believing that expensive out-of-state schools are somehow “better”. They aren’t.
Also, choose a degree program with earnings potential. Students who major in subjects like Art, History, English and Medieval Studies face an uphill battle after graduation. Although student loans can be differed, the debt will remain attached to you like that tattoo of your boyfriend/girlfriend’s name you foolishly got when you were 17. The greater your salary, the quicker your debts go away.
More on student loans and degree programs below.
2: There is a damn good reason / good payoff
The payoff must be worth the risk of taking on debt. For example, using a student loan to fund a computer science degree, for example, can easily turn positive after just a few years of working in information technology – a sector with traditionally big salaries. Business Management, Accounting and Finance degree programs are other good choices for bigger payoffs.
However, it is probably tough to argue that a $40,000 car loan was worth the risk. Less expensive cars exist – nice cars that “go”. They get you from Point A to Point B just like the expensive car.
Buying a house with a $150,000 mortgage in a real estate market where rents are high may also make sense. But even then, understand how expensive homeownership truly is.
Smart debts offer a quantifiable return.
Is there a quantifiable return on the debt? If so, consider taking on the debt if your financial standing is solid. Or if you’re a student, consider the debt if the degree program produces a reasonable expectation of a good income and dependable job prospects.
For example, the average student loan debt in the U.S. is just over $37,000. What degree programs set us up to pay off the debt quickly? On average, first year accountants make over $53,000. Finance majors average $55,400. If you’re into computers, you can expect an average salary north of $60k right out of the gate. These wages make re-paying student loans easy.
Consider job prospects, too. How likely is it to find – and keep – a job after graduation? Take a look at unemployment rates based on degree program. Areas like philosophy, hospitality and some of the “softer science” disciplines tend to result in higher unemployment. Do you want a job after graduation?
Note: This is not meant to discourage anyone from getting a degree in your chosen area of interest. But on the flip side, we all need to make a living. Choosing a degree program that gives us the best opportunity to excel, earn money and build wealth – even if that means temporary debt in the form of student loans – is the wisest choice. Choosing the right degree program provides a nice foundation for potential earnings and sets us up to quickly build wealth and maybe even retire early.
Remember that the more financially conservative you are, the greater your options. Your flexibility in life increases as your debts decrease. Losing a job becomes less impactful with a lower house payment or fewer student loans, and you also won’t find yourself as one of those Americans who becomes a slave to their debts. I was there too. I know how it feels.
Debt is NOT a “part of life“. Debt is a choice that each of us willingly accept. Do not accept debts lightly.
Steve is a 38-year-old early retiree who writes about the intersection of happiness and financial independence. Steve is a regular contributor to MarketWatch, CNBC, and The Ladders. He lives full-time in his 30′ Airstream Classic and travels the country with his wife Courtney and two rescued dogs.