Understand Your Debt, Move Toward Your Financial Goals

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05/02/2022

 
 

Nothing complicates the homebuying process like debt can. Lenders will always look at your current debt situation when approving you for a loan. Getting a handle on your debt not only simplifies the homebuying process, it also is the foundation you need to put in place to live a financially healthy life. 

Let’s explore four types of debt: credit cards, car loans, student loans, and mortgages.

Credit Card Debt

I’ve heard countless people say they wish they had been taught earlier in their lives how credit cards work. More specifically, they wish they had known how quickly you can face an uphill battle if not understood and managed appropriately. 

Interest rates on credit cards can be very high and currently average over 16%. Ideally you wouldn’t ever carry a balance on your credit card, but if you find yourself in a situation where that’s your only option, you need to focus on paying it off as soon as possible. Carrying a balance for an extended period of time is very costly and puts you in a position where you will be facing a mountain to climb instead of a hill. There are many solutions to tackling debt like Dave Ramsey’s books or educational programs. 

Car Loans

Another common debt most of us experience at some point in our lives is car loans. Interest rates and terms on these loans range all over the board. The main thing to focus on when buying a car is that you are buying a depreciable asset (in my mind more of a liability), and you need to make sure you don’t get in a situation where you owe more money on the car than it's worth. If you have an 8% interest rate 84-month loan, there is a good chance you will owe more on the car than you can sell it for. A solution for this is gap insurance, which covers you if you get in this situation, but it costs more money. Better advice: don’t get yourself into this situation and try finding a cheaper car instead. 

Student Loans

Student loans are becoming more of a problem lately than ever before. I’m not going to dive too deep into this but I would advise parents to have the conversation with their kids on how much they’re borrowing compared to the anticipated salary their child is expected to receive in the future. I know this is a tough conversation but once again, we don’t want to be facing that uphill battle early in our adult life. Take a look at this resource giving an overview of the labor market for recent college graduates.

Mortgage Debt

Last on the list is housing debt. There are differing opinions on housing debt. One end of the spectrum is paying off your mortgage and the other end is using your equity for various things. I believe somewhere in the middle of these extremes is the ideal situation for most people. Mortgage rates have been under 4% for a number of years and now are climbing - currently at or above 5%. Just over a year ago, borrowers were able to get 30-year loans around 3%. 

Since houses tend to appreciate over time, I’m perfectly comfortable not paying off a mortgage early and carrying that debt for a long period of time. My personal rule of thumb is debt on assets that appreciate is good debt and debt on depreciable assets or liabilities is bad debt. This all depends on the interest rate but that’s why you need to evaluate each situation differently. 

Summary

Managing your debt well will give you a better chance at getting pre-approved for that house you want. It’s the first step in becoming financially fit but don’t stop there. This gives you the foundation to be great savers and then you can begin your investing journey. 

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