Culture of Debt: The good, the bad and the ugly

For argument's sake, you are an average American. You financed the holidays with credit, and are left with an average of $4,440.87 in credit card debt. Add to that the national average of $21,000 in student loan debt (MSN Money), average auto loan debt of $12,500 (Marketwire.com), and average home loan debt of $69,227 (MSN Money), and you owe $107,167.87. Assuming a 5% average interest rate (which is extremely conservative), you are paying $5,358.39 annually in interest.

The numbers above are based on national averages. The amount of debt that each individual carries, and the interest rates associated with that debt will vary. Financial institutions make billions every year loaning money. They count on people like you and I thinking based on our short term needs and wants in order to charge large rates of interest in order to finance items which we cannot afford in the first place. 

Not all debt is bad. Some debt allows us to leverage our existing resources in order to achieve greater financial returns. Traditional examples of good debt would be federally subsidized student loans (for education that increases our earning power), and mortgage debt which allows us to finance a roof over our heads and build equity in an asset that serves a very important purpose. I would take this one step further. In this writer's opinion, any debt we incur that allows us to obtain a financial reward can be good debt, as long as we consider interest rates, necessity, and are aggressive in paying down the principal and interest. An example would include financing equipment for small businesses.

The debt that cripples many Americans, however is consumer debt. Automobile loans, credit cards, and other debt associated with consumer discretionary spending is dangerous in a number of ways. 

1. It is used to finance depreciating assets.
2. It carries the highest interest rates.
3. It is unsecured.
4. It is used to finance a lifestyle that we cannot afford.

Using a credit card to finance a depreciating asset:

This is a double whammy, as they say. Heres an example to quantify the danger of this one.  

I'm going to purchase a 52 inch LCD HDTV. It's sweet! I've got to have it NOW! 

I don't have the cash for it, but lucky me... I just got a new American Express card with a HUGE limit! The T.V. costs $2,500.00. I whip out the plastic, and with a thoughtless swipe of the card, I'm loading my new T.V. into the car. 

If I make the minimum payment on this single purchase, I will pay $62.50 per month. Not bad, huh? Except for the fact that it will take 17 years to pay off the balance (By which time I will likely no longer have my SWEET T.V.), and assuming an 18% interest rate, I will have payed $5,673.22 for something that has long since become worthless.

Interest rates matter:

In the above example, I used a credit card with an 18% interest rate. If my credit card carried a 9% interest rate, instead of $5,673.22, I would have paid $3,998.45. Still a horrible idea to finance a depreciating asset with credit, but interest rates truly do matter. The lesson? Check your credit report for errors, and shop around for credit cards with the best interest rates. Or, best yet, don't finance anything using credit cards.

Unsecured debt:

Unsecured debt is debt that is not attached to a purchase. Credit card debt, personal loans, and store credit are all examples of unsecured debt. The danger of unsecured debt, in this writer's opinion, is that if you end up in financial hardship and are unable to make your debt payments, there is no recourse for your creditor but to try and squeeze the proverbial blood from a turnip. They are not going to repossess your assets, because your debt is not collateralized, instead, they are going to sell your debt to collection agencies where you will be hounded, harassed, threatened, and pursued until you either declare bankruptcy or pay off the debt. 

Financing the lifestyle (we think) we deserve:

The thing that gets us in the most financial trouble. We spend more than we make. Sometimes we just don't know any better (we may not have a working budget), and sometimes we think we can afford the stuff we want because our culture surrounds us with people who have leveraged their futures in the form of credit debt in order to fund their lavish lifestyles today.

The moral of this story is short and sweet. Debt can be good. Debt can be bad. In all cases, however, if you owe money and are making monthly debt payments, you are working for your creditors and not for yourself. Understanding the financially healthy use of credit is truly one of the first steps in becoming financially liberated, and beginning to work towards securing our own futures. 

For more information, try The Total Money Makeover: A Proven Plan for Financial Fitness, by Dave Ramsey. This is a great book on paying off debt, and becoming financially secure.