You know me, I love asking questions and getting answers from all different types of people in very different stages of life. This time, I took this question to Twitter: What is the absolute worst type of debt, ever?
The answers I got were super interesting, and also kinda surprising in their variety. I expected a lot of the same sort of answers…like payday loans, for example. And I did get those answers, but I got plenty of others as well.
Goes to show you how many different perspectives that there are out there, and there isn’t necessarily a right or wrong answer to this question.
Absolute worst type of debt?
— Millennial Money (@millennialmoney) July 21, 2018
Yup, the very first answer was one I probably would have given, too. Payday loans are huge disasters. If you aren’t familiar with what a payday loan is, it’s precisely how it sounds. The idea is the borrower is getting an advance on their paycheck but from an external lending entity.
The borrower writes a check for the amount that they want to borrow, plus the fees and interest charged by the lender (which tends to be extremely high). Payday loans are relatively easy to get because the lender tends to make an excellent return on their money.
Just how much? Payday loan APRs range from 300% to more than 700%!
Talk about a raw deal.
Motorcycle loans at 23.99%
— Joseph Jimenez (@JoeRJimenez) July 21, 2018
I used to ride motorcycles too, and while I never paid a loan like that, they do tend to be higher interest loans due to the nature of the vehicle.
The debt you ignore!
— Every Day by the Lake (@EverydayLake) July 21, 2018
Yup, there’s nothing about that statement I disagree with. Anything that you ignore or let slide WILL bite you in the ass if you leave it sit long enough.
Student loans because they never go away
— Tiffany (@MoneyTalkWithT) July 21, 2018
Ah hah! I was waiting to see if someone would include student loans or mortgages as their answer, and Tiffany was the first one who said student loans.
This is a more difficult answer to respond to. On one hand, over 44 million people hold student loans that total over $1.5 trillion dollars, which is an unfathomable amount of money that Americans are indebted with.
On the other, student loans enable students to earn degrees and get well-paying jobs as a result, and college graduates earn an average of $17,500 more every year than someone without a college degree.
But, college degrees also don’t guarantee anyone a job.
I believe the best college degrees are the ones that are the most marketable. They may not relate exactly to our passions, but they stand the best chance at putting our college money to the best use.
Finding a high paying job after college enables us to pay back those loans as quickly as possible, which in turn frees us from retirement-killing debts that keep us working for years longer than necessary.
Think about a few things before you declare your major:
- First, think hard about your future and what makes you happy.
- Second, how do you want to draw your paycheck after college? Self-employment? Working for an established company? Peddling money on street corners?
- Third, what degree program will best prepare you to achieve your dream?
— Matt Caldwell (@Mcaldwell317) July 21, 2018
I have a number that might scare the shit out of you. In the United States, gamblers lose over $116 billion every year. Over 20 million Americans are in debt due to gambling, and the average gambling debt is $55,000.
How do people go into debt while gambling? They borrow (read: steal) money from credit sources like credit cards, investment portfolios and even retirement accounts hoping that they’ll “win it big” and make up the loss.
They rarely do.
The kind that comes for your knee caps after a missed payment…
— The Measure of a Plan (@measure_plan) July 21, 2018
Hmm…I probably wouldn’t have thought of this one, but it’s also hard to disagree with. 🙂
The worst type of debt, according to me!
To me, the worst type of debt is debt that doesn’t come with a significant payoff or rate of return, period. Regardless of the type, debts that leave us in a position of disadvantage are bad debts. Bad, bad debts. Horrible, these debts.
Consider the horrifying reality of how infectious debt has become:
- U.S. consumer debt is set to reach $4 trillion by the end of 2018
- Of that debt, student loans account for more than $1.4 trillion
- Auto loans and credit card debts are climbing by more than 7 percent every year
- Wolf Street calls us debt slaves
The cheap availability of credit makes it too easy to spend money that we do not have, rack up incredible amounts of debt and kill our chances at retiring before we hit 65. Low-interest auto loans have increased borrowing for cars (almost always a poor decision). Student loans continue to soar, causing the delinquency rate (more than 90 days delinquent) to increase to beyond 10%.
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.
What to do if you’re in debt
Well, pay it off of course! Naturally, that’s easier said than done. Consider these techniques:
If you are in debt:
Don’t take on additional debt – The last thing we need when escaping the dreaded stink of debt is, well, more debt. If you are already in debt, don’t willingly accept more of it. You may think this goes without saying, but there is a reason why the total credit card debt in the U.S. is more than $500 billion. That’s billion, with a b. Put another way, $500,000,000,000.
Prioritize paying off your debt – Make it your mission in life to pay off your debt. Change your lifestyle in ways that put your debt first on your list of priorities. While you don’t need to give up everything, look at where you can cut back. For example, maybe that $10,000 vacation isn’t the smartest thing to be doing with your money at the moment. Or that new BMW.
With every big expense you make, ask yourself one simple question: Is it worth staying in debt longer? If the answer is “Yes”, that’s okay. Do it. But, understand that your debts will never disappear until you make them.
Pay off high-interest debts first – Once you decide to pay off debt, get rid of those high-interest debts first. Those are the debts that you’re paying significantly more to hold. Credit card debt is a very common high-interest debt. Get rid of it. Then, proceed to your next largest debt, which might be a car or student loan. Whatever it is, get rid of it.
The one exception: I believe in giving ourselves small victories along the way. If you have a debt that’s so small that you could pay it off tomorrow – or within a few months, even if the interest rate is low, consider taking care of that one first. It’s a small victory, but it’s also an accomplishment.
Make it automated – When you don’t need to think about it, paying off debt gets much, much easier. Whenever possible, use bank transfers and/or other auto deductions from your checking or savings account to pay off debts. Set it up once, then forget about it until its done. The less that you need to think about your paying off your debts, the easier they will be to demolish.
Check out the Automatic Millionaire, by David Boch (<– affiliate link!), for an excellent in-depth look at how automation kicks our finances into high gear.
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”.
With few exceptions, 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 students can differ their loans, the debt will remain attached to you like that tattoo on your ass of your 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 an awfully 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, be sure to 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 accepts. 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.