Not All Debt Is Bad

Without borrowing money, many of us couldn’t buy a home or go to college — or even buy a car. With reasonable interest rates and good money management, debt can be a good thing. Steep interest rates or mismanagement of debt, though, can be very harmful to your financial health.

Mortgages are unavoidable for most folks who want to buy a home. Fortunately, this is a period of low interest rates, which are great for borrowers. If your FICO credit score is good (around 670 or more) or great (around 740 or more), so will be the interest rates you’re offered. Those with low scores will be offered steeper interest rates that can cost them many thousands of dollars more. (If you can delay borrowing while you beef up your score by paying bills on time and paying off debts, that can be well worth it.)

Here’s how debt can even be preferable to being debtless: Imagine that you have $200,000 and want to buy a $200,000 home that you expect to live in for 30 years. You could buy it for cash, and if the home appreciates by 3% annually, on average, it will end up worth about $485,000. (Real estate generally doesn’t grow quickly.) That’s good, but it’s not typically an asset you’d liquidate for a profit — you still need a place to live.

Instead, you might pay 20%, or $40,000, down, leaving you to borrow $160,000 at around 3.75%, a recent rate for many 30-year fixedrate loans. Over the 30 years, you’d pay a total of around $266,755 — repaying the loan plus $106,755 in interest. You’d still have a home worth $485,000, but you could have invested the $160,000 that you didn’t spend buying the house. If that sum grew at an average annual rate of, say, 6%, it would have totaled more than $900,000.

In contrast, most credit cards are charging interest rates between 14% and 25%. Pay off such debt as soon as you can. If you don’t, it’s possible to end up paying more in interest than you borrowed!