Financial Planning 101 – Debt

Credit Cards and Cash
There are two key elements to financial planning: debt and savings. While much has been written about these two topics individually, there is a direct correlation between the two. For example, if you are maxing out your annual 401(k) or IRA contribution, but have to charge your weekly groceries on your credit card, are you really accomplishing much?

In this two-part series, I’ll look at both debt and savings, and then offer some simple action items which will help you get started in moving from where ever you are towards where you would like to be with your finances.

Debt: the Good, the Bad, and the Ugly

In Proverbs 22:7 we are told, “The rich rule over the poor, and the borrower is servant to the lender.” In The Message, Eugene Peterson uses what might be described as a more instructive translation: “The poor are always ruled over by the rich, so don’t borrow and put yourself under their power.” Being debt free is a great thing but can appear to be unreachable to the average American.

If there is such a thing as “good debt” it would have to be a home mortgage. Why?  Well there are a couple of reasons. First, over the long term real estate is likely to appreciate, so you are likely to recoup some of the interest you pay in the form of capital appreciation. Second, with interest rates being so low, if you purchase a home within your budget, your mortgage payment may be in line with what you might pay to rent a comparable home or apartment. As a bonus, there is a tax deduction for the interest you pay on the mortgage for a primary residence.

Bad debt would consist of the debt incurred to buy a depreciating asset, such as a car, boat, motorcycle, RV, etc. The eagerness of banks, credit unions and other financial institutions to write these types of loans have many of us making monthly payments on something we wanted, but is probably much more than we really needed. The most practical vehicle for you to drive is the one you already own. Are you driving the vehicle you need, or is it what you wanted?

As you may have already guessed, ugly debt is credit cards and unsecured lines of credit. The reality that most people under 40 already spend 118% of what they earn highlights the problem that many of us are living beyond our means. Most of us only need one credit card, but the average in the US is four. If you have multiple credit cards and outstanding balances, you have some work to do.

The big picture question we should each ask ourselves is, “Am I managing my debt, or is my debt managing me?” It is difficult to maintain an effective savings or retirement plan when you are a servant to your lenders.

What is your debt situation like? Is it good, bad, or ugly? If you’re not where you want to be don’t worry. For the second part of this series, I’ll discuss savings and offer tips on how to decrease your debt.

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