Good Debt vs. Bad Debt: Know the Difference
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What is good debt?
Student loans
- Guideline: In general, aim for your student loan payment to stay below 10% of your projected after-tax monthly income a year after graduating. For someone who expects to earn $50,000 a year, the borrowing cap would be $29,000.
- Take action: To handle overwhelming student loans, look into repayment options such as refinancing and income-driven repayment plans.
Mortgages
- Guideline: Know how much house you can afford before shopping, and limit a mortgage payment to 36% of your income.
- Take action: Downsizing, refinancing or moving to a lower-cost area can make housing costs more manageable.
Car loans
- Guideline: Keep total auto costs, including your car loan payment, within 20% of your take-home pay. Loan terms should be four years or fewer, preferably with a 20% down payment.
- Take action: Refinancing or trading in an unaffordable car can help you manage car expenses.
What is bad debt?
High-interest credit cards
- Guideline: If you’re not making progress on your credit card debt, despite paying all you can monthly, that may be a sign you’re facing problematic credit card debt.
- Take action: If you can keep your spending under control, try out the debt snowball method, where you pay off your smallest debts first. A balance transfer credit card can make your credit card debt more affordable, though you’ll need good credit to qualify. Otherwise, a debt management plan from a nonprofit credit counseling agency might be a good option.
Personal loans for discretionary purchases
- Guideline: Personal loans can be a good option if you have a specific goal in mind, such as consolidating debt.
- Take action: If you’re facing an expensive personal loan, you may be able to refinance it.
Payday loans
- Guideline: Financial experts caution against payday loans because borrowers can easily fall into a debt cycle.
- Take action: Consider alternatives such as borrowing from a credit union or asking family members for help.