Which Loans Are OK, and Which Are Bad or Downright Crazy?

A person holding a stack of credit cards looks at stacks of papers.
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Americans have a lot of debt.

According to the Federal Reserve's quarterly report on household debt and credit for the third quarter of 2022, total household debt topped $16 trillion for the second time. After a brief decline during the Great Recession, debt has been on the rise.

Yes, there was a brief (and small) downward move during the early pandemic, but that's the lone bright spot in the trendline. Household debt has increased nearly 50% in the last nine years.

But is that as negative as it sounds? It depends. When it comes to classifying the most common forms of debt, here are the categories I would use: The (sort of) good, the bad and the crazy.

The (Sort of) Good

Why qualify "good" with "sort of"? I wouldn't call any debt "good." Necessary at times? Yes. Potentially helpful? Yes. Good? Not so much. Even so, the following types of debt are generally more tolerable than others.

Student Loans: College is expensive, and unless you or your parents did a great job on the savings front -- or maybe leveraged military service and benefits! -- few can pay for it without incurring debt. It's important, though, to borrow only what you need. Recent movement on the student-loan forgiveness front also highlights the importance of using federal student loans whenever possible.

Mortgage Loans: Despite the recent cooldown, houses remain historically expensive. And like college educations, most people will need to borrow. However, the size and emotional nature of this decision make it critical to do it right. In my experience, lenders have been willing to lend to a level that could be beyond what is prudent for the buyer. Do your homework and be your own best advocate.

The key here is to be a thoughtful and deliberate borrower. Now, let's look at "The Bad" and "The Crazy."

The Bad

Though very commonly used, use of the following types of debts should be minimized and responsibly managed.

Auto Loans: Vehicles are expensive and are a necessity for most people. As with a home, that doesn't mean the purchase should drain you financially. Think practical, not "status symbol," when you purchase a vehicle. If your all-in transportation costs (car payment, gas, maintenance, etc.) with a 60-month loan will exceed 10%-15% of your gross pay, consider a more cautious approach.

Credit Cards: Using credit cards for convenience is fine. Using credit cards for things you can't afford is not. If you don't pay off the balance each month, you'll have to pay finance charges. With the average credit-card interest rate topping 16%, that's a scary proposition and hard to justify. It makes knowing how to get out of credit-card debt critical.

The Crazy

Loan with 'Anticipation' or 'Advance' or 'Payday' in the Title: Sure, bad things happen from time to time. However, if you need a loan to make it from one paycheck to the next, or you can't survive until your income-tax return check arrives, you really need to look hard at your lifestyle and spending. Perhaps it's time to sit down with a credit counselor or visit an installation financial manager. It's, well -- crazy -- to pay obscene interest rates characteristic of these types of loans.

High-Interest Auto Loans: If the only auto loan you can get has a double-digit interest rate, you really should take a long pause and reconsider what you're about to do. A $20,000 car financed for 60 months at 12% will end up costing you almost $27,000 in total payments. It doesn't matter how much you love the car on the lot; paying an additional 30% for it after interest charges will get old long before the car will.

The perfect financial scenario for most people would be a life free of all debt. Unfortunately, perfect scenarios and real life don't often occupy the same space. Life happens, and consequently, debt happens. The trick is not to make a bad thing worse.

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