By Megan Sayles
AFRO Staff Writer
msayles@afro.com
Debt is often treated as a bad word though taking out loans and swiping credit cards is commonplace and unavoidable for most households across the country.
However, not all debt is “bad” debt. At times, taking on debt may be a necessary stepping stone in achieving a financial goal. The key is borrowing responsibly.
“While payday loans and debt with extremely high interest can be detrimental, anything that you borrow and don’t pay back can become bad debt. Good debt usually has lower interest rates, is manageable to repay and contributes to financial growth in some way,” said Channing Jones, financial wellbeing coach. “Bad debt generally does not generate wealth, loses values quickly, comes with very high interest rates and fees and some may not want to hear this, but it’s generally used to finance wants and not needs.”
Jones has more than two decades of experience in banking and entrepreneurship. She currently works at Operation HOPE, a nonprofit organization dedicated to delivering financial literacy education and pathways to economic empowerment.
While good debt is often tied to an appreciating asset, bad debt is typically not backed by an asset, according to Jones.
“For instance, a mortgage loan or a home equity loan is good debt as they are tied to your home, which appreciates over time. In addition, mortgage interest is tax deductible in most cases, offering tax advantages and lowering your overall tax burden,” said Jones. “Credit card debt would fall into the bad debt category. Rates on these products are typically higher, have account fees and are sometimes variable in that the interest rate can increase over time.”
When deciding whether to borrow, Jones said people should be looking for long-term value rather than short-term satisfaction.
She outlined several questions a person should ask themselves before taking on debt:
- Is this debt going to help me build wealth, increase my earning potential and/or improve my financial situation over time?
- Can I comfortably repay this debt?
- Will I be able to make payments without going into financial stress?
- What’s the interest rate, and is it manageable, or will it make the debt much more expensive?
- What’s the return on investment?
- Will this debt lead to better opportunities or financial growth?
- How will it affect my credit? Will it help build good credit, or could it harm my score?
Debts, like a mortgage or student loans, can be considered as strategic debt, according to Jones. As homeownership is a primary avenue for building generational wealth, a mortgage can serve as a tool in achieving that. Each mortgage payment also contributes to home equity, which can be leveraged to afford other major expenses, like starting a business, according to Jones.
She explained that student loans can act as investment in education, preparing people for better job opportunities and higher income.
Though any debt that is poorly managed can turn into bad debt, there are a few forms Jones warned against.
“I recommend staying away from costly alternatives, like payday loans or cash advance locations. You will end up paying very high interest on your own money when in reality you may just need assistance with a budget,” said Jones. “Other examples of bad debt can include high-interest credit cards or auto loans, rent-to-own agreements, co-signing for a loan that’s not yours and ultimately anything that you cannot afford to repay comfortably.”
If someone does become burdened with bad debt, Jones advised that they seek support.
“I recommend people to connect with a free financial coach or advisor like me to help them review their finances and come up with a plan and budget to get from underneath that bad debt,” said Jones. “Bad debt doesn’t need to be dealt with alone.”
