Some loans are better for your finances than others. “Good debt” includes funding that puts you in a better financial situation in the long run, while “bad debt” leads to credit problems. Student loans are typically considered good debt because a higher education can lead to the career or income you want.
Key Takeaways
- “Good debt” can include any type of debt that offers a solid return on the investment.
- Student loans are considered good debt due to their potential for long-term benefits, including increased earning potential.
- Other factors of good debt include lower interest rates, flexible repayment options, and potential tax deductions.
- However, risks associated with student loans include earning a degree that doesn’t provide a good return on investment (ROI).
Understanding Good Debt
Good debt can include any debt that pays off in the long run, although the potential benefits that can come from good debt will vary. For example, a mortgage used to buy a home is typically considered good debt since the property itself is an asset that can appreciate in value over time. Small business loans can also be considered good debt when the funds are used to launch a new company or increase profits for an existing business.
You can determine if the debt you’re considering will be good or bad for your financial situation based on whether you can repay it and how it will help you. Some debt may be good for one borrower but damaging for another. For example, a mortgage for a home you cannot afford would not be good debt, nor would a business loan in which you misspent the loan funds.
Student Loans as Good Debt
Student loans are a type of funding that’s used to pay for a higher education at a college, university, trade school, or other institution. The reasons student loans are generally considered good debt can include:
- Higher future earning potential: Data from the U.S. Bureau of Labor Statistics shows that educational attainment leads to higher earnings. For example, people with a bachelor’s degree earned an average of $1,493 per week in 2023, compared to weekly earnings of $899 for those with a high school diploma.
- Lower interest rates: Federal student loans especially come with competitive fixed interest rates that are much lower than other types of debt charge. For example, according to the Federal Reserve, the average credit card interest rate was 22.75% in Q4 of 2023, compared to 5.50% for direct subsidized loans and direct unsubsidized loans.
- Flexible repayment plans: Federal student loans can be paid off using several different repayment plans that last anywhere from 10 to 30 years. There are even income-driven repayment (IDR) plans, which require payments for 20 to 25 years before forgiving remaining loan balances.
- Potential for tax deductions: Student loan interest may be tax deductible if you meet certain requirements, whereas most other types of debt do not have any tax benefits.
- Potential for loan forgiveness: In addition to IDR plans for federal student loans that lead to loan forgiveness, there are additional forgiveness plans for federal student loans, including Public Service Loan Forgiveness (PSLF) and Teacher Loan Forgiveness. Private student loan forgiveness is much less common, typically only possible if the borrower becomes permanently disabled or dies.
Risks and Drawbacks of Student Loans
Student loan debt is typically considered good debt for many reasons, but there are potential downsides as well. They include:
- Choosing the wrong degree: While many college degrees can pay off in a big way, some college degrees actually have a negative return on investment (ROI) when you factor in the costs of a higher education. For example, a 2022 study from FREOPP showed that 23% of advanced degrees and 43% of master’s degrees had a negative financial return that year.
- Unemployment and underemployment after graduation: While unemployment rates are higher for people with lower levels of education, borrowing money with student loans and being unemployed or underemployed can lead to serious credit issues. If you cannot afford to repay your loans, you can severely damage your credit.
- Financial stress caused by debt repayment: Student loans require monthly payments for years, and your loan obligations can keep you from reaching other financial goals. This is especially true when you borrow a large amount of money and/or you have a high income that prevents you from benefiting from an IDR plan.
- Slim chance at bankruptcy: Also note that if you get into financial trouble and have student loans, these loans are nearly impossible to discharge via bankruptcy.
Student Loans Are Good Debt If:
-
Borrowing money gives you the chance to earn a college degree
-
Educational attainment leads to much higher earnings
-
You qualify for subsidized student loans, which means the government covers interest charges while you’re in school
-
You shop around to find a degree program with a solid ROI
-
You build credit with on-time student loan payments
Student Loans Are Bad Debt If:
-
You borrow more than you need to earn a degree
-
Your chosen degree has a low ROI
-
You struggle to make student loan payments, and your credit is damaged as a result
-
The school you attend is overly expensive without any added benefit
Tips and Strategies for Managing Student Loan Debt
How you manage debt can also impact whether your student loans will be worth it. These tips can help you use debt to your advantage.
- Plan and budget for student loan repayment: Never borrow for a higher education without having a plan for how much you intend to borrow and understanding what you would owe with different repayment plans. You can use the Loan Simulator from Federal Student Aid to get an idea of what your monthly payment would be based on how much you borrow for school and how long you want to spend paying the money back.
- Explore income-driven repayment plans: Be sure to research IDR plans, particularly the new Saving on a Valuable Education (SAVE) plan, which only requires you to pay 5% of your discretionary income toward undergraduate student loans each month. An IDR plan may result in a lower monthly payment, and borrowers could see their remaining loan balances forgiven after 20 to 25 years.
- Look into loan forgiveness programs: If you plan to work in public service or teaching, you should also look into loan forgiveness programs like PSLF and Teacher Loan Forgiveness, respectively.
- Build credit through responsible loan repayment: Making on-time payments on your student loans can help you build credit over time, which can help you later in life. For example, good credit can mean qualifying for loans with better interest rates and terms in the future, such as the mortgage you might need to purchase a home.
Important
Please note that on July 18, 2024, a federal court blocked the operation of the Saving on a Valuable Education (SAVE) Plan until court cases centered around the Income-Driven Repayment (IDR) plan can be resolved. In the meantime, the Department of Education has moved borrowers enrolled in the SAVE plan into forbearance, whereby they will not need to make payments, nor will interest accrue on their loans.
Options exist for borrowers nearing Public Service Loan Forgiveness (PSLF). Borrowers can “buy back” months of PSLF credit if they reach 120 months of payments while in forbearance or switch to a different IDR plan.
Does Paying Student Loans Build Credit?
On-time payments on student loans help you build credit over time. Meanwhile, late or missed payments can cause damage to your credit score that could take years to fix.
What Are the Long-Term Implications of Student Loan Debt on My Finances?
Student loan debt can have many long-term financial consequences that vary from person to person. For example, owing too much on student loans each month can make it more difficult to borrow money for other purposes, such as buying a home or a car. Large student loan payments can also make it difficult for consumers to save for retirement and other future goals.
What Are Some Examples of Bad Debt?
Bad debt can include any debt with a high interest rate or a variable rate, in addition to debts that are not secured by any collateral. Credit card debt is considered bad debt for both of these reasons.
What Should I Pay Off First: Credit Card or Student Loan Debt?
Because interest rates on student loans are much lower on average than you’ll pay with credit cards, you should pay off credit card debt first to save more on interest in the long run.
What Happens If You Don’t Pay Off Your Student Loans?
If you stop making payments on student loans, your lender will report the missed payments to the credit bureaus. Your credit score will suffer as a result, which can make it more difficult to borrow money in the future. If you remain in default on your student loans, the government can eventually garnish your wages, your tax refund, and other government payments you receive.
The Bottom Line
Student loan debt can be good debt when it helps you get where you need to be, either by advancing in your chosen profession, helping you earn more money or both. Remember that not all college degrees lead to success, and you should always strive to borrow as little as possible.
Read the original article on Investopedia.