Are student loans good debt that can open the door to a career or an insurmountable burden? Is all credit card debt a sign of reckless spending, or can it be a smart way to cover an expense? In general, no form of debt is inherently “good” or “bad.” What makes it good or bad is how it fits into your overall financial picture.
Good debt is manageable within your budget and can help you achieve your goals. On the flip side, bad debt is unaffordable and can overwhelm your finances.
Ask yourself these questions to determine if you’re dealing with good or bad debt. Then see how you can manage it.
What led to the debt?
The reason you took on debt can help you determine whether it’s helpful or harmful.
“Any debt that is taken on because people don’t have any kind of choice means they are starting out in a place of disadvantage,” says Ida Rademacher, a vice president of nonprofit think tank Aspen Institute. “That can create a spiral that can prevent people from being resilient.”
Conversely, Rademacher says, “the more helpful forms of debt can help people to become more resilient.” Student loans, for example, may enable a career that offers a high salary, making you more financially sound.
Think about whether you incurred the debt:
To achieve a long-term goal: Student loans and auto loans can fit in this category. These debts can help you move ahead in life, so long as you don’t take on too much.
Out of convenience: These are debts you incur to make other aspects of your life easier, such as when you have a big one-time expense and don’t want to deplete your savings. They can be benign if they’re helping you manage your overall financial picture.
Due to an emergency: Desperation debt can be dangerous. A need for cash in a hurry can leave you with limited options and result in high interest costs.
Bottom line: Debt taken to achieve a goal or out of convenience can be useful as long as you have a plan for paying it off. To avoid desperation debt, build an emergency fund. A 2016 report from public policy think tank Urban Institute found that savings as small as $250 can help consumers avoid missed bills and even eviction.
Is your debt affordable?
Comparing your debt load with your gross income can be a helpful tool for seeing if it’s manageable or becoming too large to tackle on your own. Leaving aside mortgages and student loans, since they’re generally more manageable forms of debt, here are some guidelines to consider:
Debt load up to 15% of income: This amount is likely affordable but is worth addressing. If you’re carrying a moderate credit card balance, for example, paying it off can free up cash and save on interest.
Debt load from 16% to 39% of income: Debts in this range get increasingly difficult to pay off. You may be able to make them more affordable by reducing interest or payments, such as with a balance transfer credit card or a personal loan. If you can’t qualify for one of those, you could explore a debt management plan with a nonprofit credit counselor.
Debt load of 40% or more of income: Debt loads this high can be insurmountable. Use the free consultations offered by many nonprofit credit counselors and bankruptcy attorneys to see if debt relief might be right for you.
Bottom line: Know how your debt compares with your income and use that perspective to understand which approach is the most logical.
How is your debt affecting your life?
Think about how debt is impacting your life overall, says Thomas Nitzsche, media manager at nonprofit credit counseling agency Money Management International.
“If your debt is something that is hanging over your head and you’re worrying about it constantly, that’s something you should address,” he says. Any debt that affects your mental health or significantly diminishes your quality of life is a bad debt.
Nitzsche advises taking an honest look at your situation and making a plan to resolve debt through a payoff approach like debt snowball — focusing on your smallest debts first — or by seeking debt relief. “Realize how uncomfortable you are with your debt and that it’s in your power to make changes.”
Bottom line: Debt doesn’t have to rule your life. If you’re feeling overwhelmed, take the first steps to resolve your obligations.
This article was written by NerdWallet and was originally published by The Associated Press.
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Sean Pyles is a writer at NerdWallet. Email: email@example.com. Twitter: @SeanPyles.
The article Is Your Debt ‘Good’ or ‘Bad’? It Depends originally appeared on NerdWallet.