Last week’s Finance Friday reviewed some of the good debt we can carry. This week, we’ll turn our attention to bad debt, while we save the truly toxic debt for next week.
Three Bad Debts to Have:
1. Mortgages With a High “Loan to Value”
Loan to value (LTV) is the comparison of how much someone owes on a house compared to how much the house is actually worth. A homeowner who buys a $200,000 home and carries a $160,000 mortgage has an LTV of 80%.
But let’s be honest, putting a full 20% down when buying a home can be difficult. In fact, very few first-time home buyers are able to accomplish this. Data from the National Association of Realtors indicates that the majority of first-time home buyers average about 6% down when buying their first home.
Small down payments aren’t ideal, since having an LTV on your mortgage above 80% often results in higher interest rates and the need to carry private mortgage insurance (PMI). PMI is the extra monthly payment that’s required if your primary mortgage is over 80% of the value of the home. This can often exceed $1,000 or more per year on a $200,000 loan.
Does that mean you should wait until you have the full 20% to put down before buying a home? Not necessarily. It just means that if you do choose to buy a home with less than 20% down you should prioritize paying the loan down below 80% so you can drop the PMI. Sometimes it even makes sense to refinance the whole mortgage after a few years to lower the interest rate and drop the PMI at the same time.
2. Credit Cards With Rates Around 10%
We’ll talk a great deal about credit cards next week when we look at toxic debt (in fact, that might be all we talk about), but some credit cards actually avoid the toxic label. With the exception of 0% introductory rate cards, I rarely see interest rates on cards lower than 10%. If you have a card in this range, it’s not good debt, but it’s not quite toxic either.
Let’s face it, life happens. And sometimes that means using a credit card to get out of a jam. Whether it’s a major car repair or an unexpected medical expense, you’ll want to prioritize paying these off as quickly as possible.
3. High Interest Rate Versions of All the “Good Debt” We Talked About Last Week
- Mortgages over 4%
- Car loans over 5%
- Education loans over 5%, even if they’re advancing your career
- Any education loan (regardless of rate) that’s not advancing your career
- Loans for the operating expenses of a business that’s not succeeding
Do you have a lot of bad debts? If so, it’s time to set up a financial review session.
Contact us today to meet with one of our advisors.