Total U.S. consumer debt was $11.28 trillion in Q3 2013, according to the New York Federal Reserve. Granted, that number is well below the all-time high of $12.68 trillion set in Q3 2008; but to put it in perspective, the International Monetary Fund estimated the total gross domestic product (GDP) of the U.S. to be $17 trillion in 2013. The worst kind of debt? The debt that goes unmanaged. We would all love a debt-free life, but sometimes certain types of debt are unavoidable. Learn how to limit and manage your financial burden, and you'll take a significant stride toward financial freedom.
The Good – Student Loans
Not only did total student loan debt surpass the $1.2 trillion mark in 2013, but students borrowed another $100 billion in fiscal year 2014. Naturally, default rates are also on the rise—the most recent data from the Department of Education shows two-year default rates rose from 9.1 percent in 2010 to 10 percent in 2011.
Simple to obtain, student loans can give young adults a feeling of financial freedom. Let's take a look:
- Easy to obtain
- Better chances of employment (if you graduate)
- 10-year term, lower interest rates
- Forbearance available during difficult times
- Income-based repayment plan available
- Easy to obtain
- No restrictions on use
- Borrower usually only has a slight understanding of income-to-debt ratio at this point in time
- Interest accrues during times of forbearance
- Get a part-time job (some universities offer lower tuition for university employees)
- Complete your undergrad requirements at a community college
The Bureau of Labor Statistics reports that college graduates have a higher potential for income than those without, but you still need to know about the impact of these loans. Calculate the amount your monthly payment will be when you graduate. Financial freedom is entering the workforce with little to no debt, not being tied to a job to pay for the last four years.
The Bad – Credit Card Debt
Credit card debt isn’t far behind student loans when it comes to burdening American consumers. Total U.S. credit card debt was $854.2 billion as of April 2014, according to Federal Reserve data analyzed by Nerd Wallet. Credit cards are a necessary evil, however, as they are often required to travel, rent a car and establish credit history. But if you use them to purchase items and aren't paying the balances each month, you are spending more than you earn.
- It's a short-term loan
- Provides fraud protection
- Potential benefits: cash back, frequent-flyer miles
- Establishes credit history
- Interest rate increases the price of items you purchase if not paid in full every month
- It's easy to spend beyond your means
- Unexpected rate increases
- Hidden fees
- Build an emergency fund for unexpected expenses
- Live within your means
- Create and live by your budget
- Pay balance in full every month
If you must use credit cards, pay the balances in full each month. A credit card can afford you a short-term loan that will cost absolutely nothing, if managed correctly.
The Ugly – Payday Loans
With interest rates sometimes as high as 360 percent, avoid this debt at all costs. Payday lenders charge high interest rates and fees on loans that are due the very next time you get paid. The interest is typically more than the fee to extend the term of the loan.
Strategies To Pay Down Debt
A 2013 study by the University of Southampton found that people with excessive debt are three times more likely to develop mental health issues. High balances and late payments can also cause your credit score to suffer.
FICO weighs five factors when determining your score, with 65 percent of it consisting of the amount owed on your trade lines and payment history. It also factors in your debt-to-available-credit ratio as part of the score. Focus on paying down cards that are maxed out first.
Some people are taking advantage of the healing housing market to take out home equity loans and consolidate their debt at a lower interest rate. If you receive regular payments from an annuity or structured settlement, you may be able to sell your future payments to a company like J.G. Wentworth. The lump sum of cash can then be used to help pay down your highest balances.
Closing credit card accounts is not necessarily a good move for your credit score. But if you decide to do so for whatever reason, keep the oldest accounts open and close newer ones. Length of credit history is also a factor in your FICO score.
Debt should only be accumulated as a means to some greater end. Stick to this simple strategy to keep your finances as healthy as possible.