A debt by any other name is still a debt

When employees go about considering how much debt is too much, keep in mind that housing, transportation, essentials (food, utilities, etc.) should only comprise 50% of an employees take home pay.

When it comes to debt, many employees don’t know good debt from bad debt or a line of credit from a student loan.  Not all debt has the same impact on retirement readiness for employees. Some financial experts say that if a purchase increases your net worth or has future income value, it’s a good debt, if not, it isn’t. But there are other impacts debt has to retirement readiness. Below, we list a few key distinctions employees may not know when making budgeting decisions that could impact their retirement readiness.

Installment vs. revolving debt. Installment debts are fixed payment debt where the life of the debt is set. Revolving debt, like credit cards, can be carried forever and allows for short-term increases and decreases. Installment debt often has favorable tax treatment and often impacts credit scores in a positive way (for home loans). Revolving debt often impacts credit scores in a negative way. The key to installment debt and revolving debt is how it is used. Even housing loans can be bad if they are too large for the income of the borrower.

Secured vs. Unsecured: A secured debt is something with an asset “tied” to it, that is a thing that could be sold to repay the loan. Mortgages and car loans are obvious forms of secured loans, as the house or car can be repossessed by the lender and resold. Employees may not know, however, that some states allow a lender to foreclose or repossess the secured asset and still sue for any remaining balance.

Most employees spend more than the recommended 30% of their income on housing. With housing loans marketed as investments or positive debt, it could be that employees are taking on too much debt in this area. Employees may not understand how recent tax law changes impacted the tax-deductibility of mortgage related expenses. Another key area employees may need to learn about are they differences between conventional mortgages and government-backed mortgages (like Federal Housing Authority (FHA) or Veteran’s Administration (VA) loans).  Conventional mortgages require, usually, 20% of the purchase price to be paid as a down payment, whereas FHA loans require only 3%, substantially less. Loan specifics, like PMI rates, and interest only loans can have substantial impact on the amount an employee pays over the life of the loan.

For young parents wanting to level up in their careers and also for older parents who may need to catch up on retirement readiness due to periods of unemployment, education debt may be a concern. The key point for many employees to consider in student loans, in addition to amount, may be the lender. There are significant differences between federal and private loans, like mortgages, that may have an impact on the amount an employee pays over the life of the loan. The two lenders also differ, usually, in the flexibility they provide in restructuring payment plans if the borrower or employee has a hardship, like a health crisis or period of unemployment.

When employees go about considering how much debt is too much, keep in mind that housing, transportation, essentials (food, utilities, etc.) should only comprise 50% of an employees take home pay. Many employees tie themselves down to car loansthat are either too expensive or have too long a period of repayment (the average loan is 69 months or nearly six years). Longer payment periods mean more interest paid over the life of the loan. Other areas employees may benefit from learning about include the method of calculating interest on the loan, e.g., whether it is simple interest (paid on principle) or pre-calculated (a fixed amount per month which doesn’t change with a decrease in principle).

When it comes to credit cards, there is almost nothing good about that debt. Rewards are only a good idea if you know and pay your balance every month.  For those with excellent credit, using a high reward credit card that has a low interest rate may be a smart move. But for most borrowers, the rewards could be eaten up by the high interest rate. Employees may need education on how a late payment could raise their interest rates, in addition to triggering fees.

Know your Rights: Employees who do struggle with paying off their credit cards or other debt, may not know their rights under the Fair Debt Collection Practices Act. That Act protects borrowers from harassment by lenders in certain circumstances.

Avoid at all costs: Payday loans are the worst form of debt an employee can encounter. While they do provide cash to those in a crisis, their rates can effectively be 400%. Payday loans may be more common among employees than you think.

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