Borrowing is a part of the average American’s life. You get a loan to buy house, a car and go to school. Many also borrow for TVs, furniture, appliances, vacations, remodels and practically anything else. A mortgage or student loan isn’t a big deal is it? Everyone finances this kind of stuff, right? Most do finance these types of purchases, but give little regard to the long-term impact that it has on their personal finances.
The average American has over $53,000 in debt. This is skewed heavily by mortgage debt. Those without a mortgage have debts totaling $11,600 on average whereas those with a mortgage owe approximately $209,000. One-third of these people get in over their heads, finding their debt to be too much and end up in collections (1).
Rushing into debt without even considering the impact that it has on your life can set you back years. A loan that goes bad will cost you thousands in interest and fees on this loan and thousands more for the next several years. Your credit will be terrible and you’ll be forced to pay much higher rates on future loans.
A low credit score also makes employment more difficult. Many prospective employers will check your credit as part of a job application. Poor credit indicates that you have poor decision making skills and can’t handle responsibility.
Failure to consider the impact of debt on your future can be detrimental.
Does Debt Ever Make Sense?
Debt isn’t evil. There’s nothing inherently bad about debt itself, it just adds risk to your life. Debt comes with pros and cons. It can be a great tool. It can provide an opportunity for an education that would otherwise be unavailable. It can provide leverage for purchasing an appreciating asset, such as real estate. There’s no blanket answer. You just have to look at the long term effects of taking on this long term debt.
Take student loans for example. A college degree has a massive impact on your earning potential. Earning potential with just a high school diploma is $35,400. A bachelor’s degree nearly doubles that to $65,000 (2). With figures like these, it’s hard to argue against getting a student loan to attend college. You just have to be smart about choosing an affordable college and stick with the program long enough to actually graduate.
Where people get in trouble is going to a big, expensive school, using their student loan money for living expenses and then failing to graduate. These are the people who find themselves with the $35k earning potential and $70k in student loan debt. These are the people that we’re talking about that don’t consider the long term effect of debt.
Another example is a mortgage. If you’re smart in choosing a home in good area and that you can actually afford, a mortgage makes sense. If you’ve leveraging yourself up to your eyeballs you’ll likely find yourself in trouble quickly. Furthermore, if you fail to consider the long term effect of this debt, it will cost you a tremendous amount of money. Choosing a 15 year mortgage over a 30 year saves tens, if not hundreds of thousands of dollars. For example, on a $160,000 mortgage, a 15 year mortgage at an interest rate of 4.5% would save $88,893 over a 30 year (3).
These are just two examples where long term debt makes sense if you think about the impact that it will have when you make your decision.
Always Look to the Long Term
Always think about the long term effect before you finance something. Financing a TV doesn’t make sense. Over the long term what will that TV be worth? Nothing. Same thing with a vacation. It’s worth nothing by the time you’ve paid off your loan.
On the other hand, a college education or a piece of real estate will likely be worth more once the loan is paid off. These type of purchases make sense.
Finally, don’t forget to include the element of risk. A loan always increases the risk. No matter the type of loan, there’s always a risk that you won’t be able to pay it off causing a whole host of issues for you.
Always consider the long term effect of long term debt.