Debt: The Good, the Bad, and the Ugly

Physician's Money Digest, January 2007, Volume 14, Issue 1

The word "debt" often elicits a stomach-churningkind of anxiety. And based on the troublepeople find themselves in when credit cards getout of hand—making debt payments that swallow achunk of their income—the anxiety is justified.

The truth of the matter is that debt, when carriedin the right place and in the right proportion to yourincome, is a good thing. An example of good debt isdebt in the form of a mortgage or student loanbecause it helps you achieve your goals and can leverageyour wealth. In fact, debt is necessary if you aretrying to establish the all-important credit rating; takinga loan without one or with a poor one is difficultand sometimes impossible—and scorching your creditscore can take just a couple months, while restoringit to a favorable range takes much, much longer.

Rules of Thumb

While mortgage debt is a good debt, keep in mindthat it should not exceed 28% of your gross income,while your total debt should be limited to no morethan 35%. And even though it is smart to carry amortgage, it's even smarter to make sure you havethe best rate possible. This is something you shouldbe checking quite often. Although interest rates havecrept up, they are still at historically low levels. Nowis a great time to renegotiate your existing mortgageif you haven't already done so, which is an easy wayto reduce your monthly payments.

Resources Available

A number of resources are available for you tocheck the going rates. One reliable Web site is www.bankrate.com. If you see rates lower than you're currentlypaying, contact a mortgage broker.

And, one more suggestion experts make related tomortgages: Make sure you have adequate disabilityinsurance. Home foreclosures due to disability countfor 90% of the total. Therefore, this insurance is yoursafety net in the event of an unforeseen disability.

The Bad and Ugly Debt

At the very top of the list, the worst type of debt iscredit card debt. It's important to avoid being nailedby interest rates by paying off your credit cards everymonth, because interest rates charged on credit cardbalances are exceedingly high—sometimes as high as24%. And, unlike your mortgage, credit card interestpaid is not tax deductible. So, when you're temptedto pull a credit card out of your wallet at the cashregister, do not spend more than you make or canafford to pay off each month. If you adhere to thisimportant principle, then you will eventually be freeof credit card debt.

Just remember, debt is a good thing, as long as youhold to the healthy kind, and keep it in correct proportionto your income.

Katherine B. Paal, MBA, CFP®, CTFA, is a Certified FinancialPlannerpractitioner at Heritage Financial Consultants inLutherville, Md, and is an investment advisor representative,registered representative, and licensed insurance broker withLincoln Financial Advisors, a registered investment advisor andbroker/dealer (1300 York Road, Lutherville, MD; 410-339-6675). She welcomesquestions or comments at kpaal@LNC.com. This information should not be construedas legal or tax advice. You may want to consult a tax advisor regarding thismaterial as it relates to your personal circumstances.