Being trapped in a cycle of debt is a hindrance to consumers who are woefully behind in saving for retirement, but not paying off a mortgage or taking out student loans is often a favorable alternative.

The term good debt appears to be a misnomer for many consumers who are already saddled with credit card debt or student loans, but taking your time to pay off a low interest mortgage could be an advantage since the extra money can be put to work in the stock market and garner more savings in a 401(k) or IRA for retirement.

"Good debt is anything that leads to a higher payoff later, such as a mortgage on a house that appreciates in value or a student loan that translates into a degree with higher future earnings," said Greg McBride, chief financial analyst for Bankrate, a NewYork-based financial data and content company.

While paying off your debt is a good rule of thumb, since interest rates for mortgages remain historically low, any leftover money could be saved and invested in retirement accounts such as 401(k)s and IRAs, 529 college savings accounts and health savings accounts (HSAs), he said. Equity in a home is not always accessible, especially if there is a downturn in the economy and buyers are scarce.

Understanding how to manage your debt and the repayment terms is critical to eliminating it as soon as possible to avoid paying high interest or late payments, said Jeff Golding, chief growth officer at IRH Capital, a Northbrook, Ill.-based financing company.

"Debt when used properly and in moderation is fine," he said. "Taking on certain types of debt can be a wise financial decision. You don't have to pay cash for everything."

What is Considered Good Debt

Not paying off debt is anathema for some consumers who have struggled with saving money for emergencies. Many type of loans are considered good debt such as a 30-year mortgage. Keeping the mortgage and not paying it off early make sense because the extra money can earn more in the stock market, said Bill DeShurko, president of 401 Advisor, a registered investment advisor in Centerville, Ohio.

"With interest rates so low, sometime in the next 30 years your mortgage will seem like a bargain after rates rise," he said. "With inflation, the present value of the loan proceeds will far exceed the future value of 30 years of payments."

Another benchmark of good debt is when the loan is to invest in yourself financially.

"Student loans are fine if you can reasonably expect to earn more money with the education than without," said DeShurko. "Otherwise, learn to be a welder."

Investing in a small business that will appreciate over time is a good investment, he said.

More debt is good?
More debt is good?

Some debt such as a car payment falls under the category of a "necessary evil," DeShurko said.

"With cars so expensive, it is really hard to own cars without payments," he said.

The key is to focus on how much cash flow you have after taking on the car loan.

"Don't strap yourself with a payment," DeShurko said. "Lease only if the lower payment allows you to either pay off other debt sooner or increase investing in something like a 401(k)."

Auto loans are only considered a good form of debt if negative equity from the last auto loan was not rolled into the loan and it is not a high-interest subprime loan, said Jim Triggs, a senior vice president of counseling and support of Money Management International, a Sugar Land, Texas-based non-profit debt counseling organization.

Stock owners who want to pay off higher interest rate debt such as credit cards or pay for college tuition can borrow from their brokerage account. Interactive Brokers, a Greenwich, Conn.-based global brokerage firm, offers loans ranging from 1.41% to 2.66% based on the amount. Investors who borrow up to $100,000 can obtain a rate of 2.66% while those who borrow $200 million or more can receive the 1.41% rate.

"Our loans are secured by your stock," said Steven Sanders, executive vice president of product development and marketing of Interactive Brokers. "This is not for everybody."

These loans are an alternative to financing a new car, paying off debt or obtaining a HELOC. The average household debt is $16,048 as of September 2017, according to ValuePenguin, a personal finance website and the average variable credit card interest rate is 16.7% as of Oct. 4, according to Bankrate. An investor with a monthly credit card payment of $223.33 who borrowed from their brokerage account would pay $35.57 in interest and save $187.76.

In the worst case scenario, if your stocks declined in value and you lacked enough money to cover the loan, Interactive Brokers would sell your remaining stocks in real-time.

When Debts Become Bad Ones

Bad debt is a result of consumption, including vacations and dining out or ones being incurred due to a lack of savings such as a car repair or family emergency, McBride said.

"Bad debt often carries higher interest rates, while good debt tends to come with lower rates and potential tax deductibility," he said. "It is important for consumers to accurately differentiate between good debt and bad debt so they can limit borrowing only to when necessary and can make prudent financial decisions on avoiding debt and building a solid financial foundation."

Consumers saddled with debt should prioritize their repayment and start by focusing their efforts on paying down the bad debt such as credit cards, high rate consumer loans and costly private student loans, McBride said.

Time to hit the mall.
Time to hit the mall.

"Good debt can often take a back seat to funding retirement accounts or other investment opportunities when you have spare cash," he said.

While student loans are often a good option, borrowing too much in the form of private ones can be a barrier to buying a home or saving for retirement.

"Student loans can saddle people with debt for decades and the idea of working your way through college seems to be lost on some people," said Ron McCoy, founder of Freedom Capital Advisors in Winter Garden, Fla. "Cash advance stores and pawn shops are the worst and consumers will pay through the nose to borrow there."

High interest payday loans are among the most toxic forms of bad debt, said Bruce McClary, spokesperson for the National Foundation for Credit Counseling, a Washington, D.C-based non-profit organization.

"These poisonous products are often viewed as a financial lifeline of last resort and have a reputation for trapping cash-strapped consumers in a seemingly unbreakable cycle of debt," he said.

Taking out secured and unsecured subprime loans such as car title loans and unsecured signature loans from finance companies as well as subprime mortgages can also be detrimental because the double digit interest rates can be difficult to tackle.

"Knowing the difference between a dangerous debt trap and a more reasonable financial alternative can result in substantial savings, healthier credit and better financial stability over time," McClary said. 

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