Two weeks ago, The Motley Fool published a fantastic summary of the average American's financial situation, and, while the numbers are mixed to some degree, one thing is clear: Americans have a lot of debt.
In 2022, total household debt stands at $16.5 trillion. Much of this - 79% - is "good" debt in that it is for either mortgages - 70% or $11.39 trillion - or automobiles - 9% or $1.5 trillion. Mortgage debt is generally considered "good", because over time home prices usually rise, enabling most people to build equity to draw upon as an asset later. A little more controversially, I consider automobile debt to be "good" debt with important caveats: the financed-vehicle must enable necessary transportation to and from an income source (job), and the monthly payment must not exceed 10% of a person's monthly income. Safe, reliable commuting to and from work is one of the single biggest barriers for low income households to finding and retaining employment, so the acquisition of a car that fits within 10% of a person's monthly budget is a sound investment. Buying an unnecessary second or third car, or buying a model that stretches your monthly finances, however, can easily be categorized as "bad" debt, because it's unnecessary and does not build wealth, so like all financial decisions, situational specifics are an important consideration.
On the topic of "bad" debt, one of the absolute worst forms of debt is credit card debt. This is because credit card debt almost always has punishingly high interest rates - currently between 15-20% - while interest rates for mortgage and automobile debt tend to be much lower - currently around 6% for mortgages and 2-6% for cars. Additionally, credit cards almost exclusively fund unnecessary short-term consumption (e.g., clothes, entertainment) instead of a long-term asset - like mortgages - or enabling reliable income - like automobiles. This is why it's critical that credit card balances be paid off in full every month, but this raises the question as to why you might carry a credit card if you can afford to pay it off every month; simply paying in cash or with a debit card might be a better option. Credit cards do provide the benefit of improving your credit score if you can reliably pay them off each billing cycle, but they also carry the risk of sinking you into debt if you should fall behind on the balance. To that point, The Motley Fool's summary includes the most recent data available on the median revolving credit card balance; it's over $1,000. The revolving balance is the amount that is carried from month-to-month and is therefore not paid off each billing cycle. Assuming a 15% interest rate, that median revolving balance will accrue $150 a month just in interest, not including late fees or any other charges a credit card company might apply. On a positive note, The Motely Fool reports that, "the delinquency rate of credit card loans...remains well below levels over the past 30 years." In the event of a economic downturn, however, this will be important to watch.
You can read the entire article from The Motley Fool here.
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