What Is the Worst Debt You Can Have?

Is it student loan debt, credit cards, a mortgage — or something else? Even the experts don’t always agree on which debts are “good" and which ones are “bad,” so imagine how confusing it can be to consumers who are dealing with debt!

Student Loan Debt

• College graduates, on average, still earn significantly more over their lifetimes than those without a college degree. In that sense, student loan debt can be considered an investment that pays off in future earning power. In addition, students may be able to defer payments on their student loans during times of economic hardship (albeit, usually at a cost), which makes them more flexible than other types of loans. In addition, borrowers may be eligible for reduced payments and loan forgiveness under the Income-Based Repayment Program or other loan forgiveness programs.  Unfortunately, the loans are often given to young people with no credit experience and no clue how they will pay them back. Balances are often high, and the jobs borrowers counted on to make payments may be non-existent. (Some borrowers never graduate, which means they have debt but no degree to increase their earning power.) Finally, unlike every other type of consumer debt, it is very difficult to discharge balances in bankruptcy.  How does student debt affect credit scores? Even large balances typically don’t hurt credit scores as long as the payments are made on time.

Credit Card Debt

• While making minimum payments on credit cards is not a great idea over the long run, having that option can come in handy in a financial pinch. It can give cardholders time to get back on their feet without ruining their credit.  However, with interest rates hovering around 15 percent on average — and more than 20 percent for some borrowers — credit card debt is often the most expensive kind of debt consumers carry. And with the low minimum monthly payments that issuers offer, cardholders can find themselves in debt for decades if they aren’t careful.  When consumers can’t pay back credit cards, they don’t have that much to lose — at least when compared to falling behind on a home or auto loan. Sure, a credit card issuer may be able to sue a cardholder to collect, but that usually happens only after months or years of not paying, and after there’s been an opportunity to work out some kind of settlement on the debt.  As far as credit scores are concerned, as long as cardholders keep balances low (usually below 10 to 20 percent of their available credit), and make minimum payments on time, credit card debt should not hurt credit scores.

Mortgage Debt

• Over time, home ownership remains one of the key ways average Americans build wealth. If you are able to keep up with your home loan payments, eventually the home will be paid off and provide inexpensive housing or rental income. Equity that has built up can be accessed through a reverse mortgage or by selling the house, or it can be passed along to heirs — sometimes tax-free.  If you wonder how bad mortgage debt can be, just ask the owners of some 8.8 million homes that CoreLogic said had negative or near-negative equity as of the second quarter of 2013. That means those owners owe close to, or more than, what the property is worth.  That also means they can’t sell those houses without shelling out money to pay off their mortgage or doing a short sale that damages their credit scores. Even for those who aren’t underwater, rising taxes and/or insurance premiums, the cost of maintenance and loans that typically take 30 years to pay off can make one’s home feel like a financial prison at times.  When it comes to credit scores, this type of loan will generally help, as long as payments are made on time. Even large mortgages shouldn’t depress credit scores, unless there are multiple mortgages with balances. That’s usually a problem that affects real estate investors, though, not homeowners with one or two homes.

Tax Debt

• The IRS offers repayment options that may allow a tax debt to be paid off over time at a fairly low interest rate. (Similar programs are available for state tax debt in many states.) And unlike applying for a loan, you don’t have to have good credit to get approved for an installment agreement. If you owe the Internal Revenue Service or your state taxing authority for taxes you can’t pay, you can suffer a variety of painful consequences. If a tax lien is filed, your credit scores will likely plummet. In addition, these government agencies usually have strong collection powers, including the ability to seize money in bank accounts or other property, or to intercept future tax refunds. The good news when it comes to credit scores is that tax debt itself isn’t reported to credit reporting agencies; a tax lien is the only way that it may show up. By entering into an installment agreement, you may be able to get a tax lien removed from your credit reports, even before you’ve paid off what you owe.

Auto Loan Debt

• Many consumers budget for a car payment, and as long as they aren’t hit with unexpected expenses, they are able to make this payment a priority. In addition, borrowers may be able to refinance their auto loans and lower their monthly payments. Plus, cars often get people to work, where they can earn the money they need to pay off debt. The average auto loan now lasts five and a half years, and some 12 percent last six to seven years, according to Edmunds.com. That means payments will last long after that new car smell has worn off and well into the years when maintenance and repair costs start creeping up. Even more troubling, these borrowers may be stuck if they need to sell their vehicles since they may be “upside down,” owing more than what they can sell their car or truck for. Vehicle loans that are paid on time can help credit scores, and are rarely a problem unless someone has several car loans outstanding at once or misses a payment.

The Worst Kind Of Debt

• When it comes down to it, the worst type of debt is, the one you can’t pay back on time . If that happens, your credit scores will suffer, your balances may grow larger due to fees and interest, and you may find yourself borrowing even more as you try to keep up with your payments.  You can find out how your debt affects your credit using from a variety of online credit resources. In addition to your credit score, you’ll find out whether your debt is lowering your credit score.