Clearing the Fog

The mere sound of the word hangs in the air like a thick, gray fog. In its midst, you feel hopeless, trapped and confused. Which way should you turn? How can you see your way out of a cloud of swirling debt?

If you have debt, you’re not alone. About 77% of U.S. households have some kind of debt, according to the Federal Reserve. It’s how many families buy homes and cars, fund their children’s educations, and purchase other items they need now, but can pay for over time.

Not all debt is bad. Unfortunately, it can add up quickly. Americans’ household debt totaled $17.69 trillion in the first quarter of 2024, according to the Federal Reserve Bank of New York. And as debt rises, so do delinquencies (payments 30 or more days past due) – especially among young people.

If debt is shrouding your life, you can find your way out of the fog. Here are some factors to help you determine where to turn first.

Mortgage debt

Debt can be classified as either “good” or “bad,” though each type has both pros and cons. “Good” debt generally carries lower interest rates and has the potential to increase your net worth, generate income, or significantly improve your life.

A home or real estate mortgage is one type of “good” debt. Property value tends to appreciate, mortgages tend to have lower interest rates, and buyers can build equity (the difference between what’s owed and what the property is worth). You can receive tax benefits for buying your home (versus renting), sell your home for a profit, or rent it out for income.

It can be tempting to try to pay off your mortgage early, since it comprises the largest share of most families’ total debt. Eliminating your mortgage payment can save you tens of thousands of dollars in interest over the life of your loan and improve your credit score. But there are trade-offs.

The extra money you apply to your mortgage could leave you with less cash flow for daily expenses, an emergency fund, investing for higher returns (though not guaranteed), or paying off higher-interest debt. Plus, you could lose valuable tax advantages.

Student loan debt

Student loans are another type of “good” debt because higher education can substantially increase your earning potential. According to the U.S. Bureau of Labor Statistics, the average college graduate earns $579 more per week (about $30,000 more per year) than a high school graduate.

If you’re debating a college decision, it may be a good idea to weigh the cost of a degree compared to what you can expect to earn in your chosen field. If the earnings don’t match the investment, student loans might be a “bad” debt to incur.

Your student loans could be considerable. However, federal student loans usually have a low interest rate. If you have higher-interest debt, you may want to concentrate your resources to paying that off before turning to your student debt.

Auto loan debt

Debt is considered “bad” when it’s used for purchases that don’t increase your net worth, depreciate quickly and bear higher interest rates. Though a personal vehicle is a necessity for many people, you’ve probably heard they start losing value “as soon as you pull off the lot.”

According to Carfax, the value of a new vehicle drops by about 20% in the first year and about 15% each subsequent year you own it. After five years, it will retain only about 40% of its purchase price.

If your auto loan has a higher interest rate than your mortgage or student loans (or if you don’t have these types of debt), paying off your auto loan early could save you money on interest and improve your credit score (after a small initial drop). It will also reduce your debt-to-income (DTI) ratio and increase your cash flow. This can help if you’re saving for a large purchase, like a new home.

Be sure to check your loan contract for prepayment penalties (usually 1% of the original loan amount, according to Investopedia).

Credit card debt

The pitfalls of credit card use are well-known: high interest rates, averaging over 20%, that make repayment difficult; purchases of clothes, vacations and other items that depreciate almost immediately; and the ease of overspending. It’s the definition of “bad” debt, and unless you’re able to pay it off in full every month, it’s a vicious cycle you should escape as soon as possible.

Lifting the fog

While most Americans have debt, no one’s circumstances are the same. If you’re living under a cloud of debt, talk to your Modern Woodmen representative and other financial professionals. They can help you with an individualized plan to save money, pay down your debts, and clear the way for a strong financial future.

By the numbers

U.S. households owe:

• $1.12 trillion on credit cards.
• $12.44 trillion on mortgages.
• $1.62 trillion on vehicle loans.
• $1.6 trillion on student loans.

Source: Federal Reserve Bank of New York