Thinking about borrowing money for something?

Borrowing money is a common practice, especially for things like a house, car, or college. But people borrow money and go into debt for a lot of other reasons, too.
It’s crucial to understand when it makes sense and when it doesn’t. With current consumer borrowing habits reaching new heights, navigating the complex world of debt is more important than ever.

• In 2023, U.S. consumer debt reached a staggering $17 trillion, highlighting the critical need for financial literacy.

Ready to learn more about when borrowing makes sense and when it doesn’t? Here’s what you need to know.

3 Practical Reasons to Borrow Money

When it comes to making big life decisions, borrowing money can be a smart move. But it can also get you deep into debt that could impact your bottom line for years (Don’t do that, OK.) Here are three practical reasons to borrow money:

1. Investing in Education
Taking out student loans can be a wise investment if it leads to higher earning potential.

• According to the U.S. Bureau of Labor Statistics, individuals with a bachelor’s degree earn approximately $1,305 per week, compared to $781 for those with only a high school diploma.

While student debt can be burdensome, the long-term financial benefits often outweigh the initial costs.
Before you borrow for education:

• Evaluate annual income, salaries, and earning potential in your chosen career field. Upon completion, will your degree/training help you earn more money?
• Consider state-schools and technical programs that may offer lower tuition rates to complete a degree program or training compared to private schools
• Identify other ways to pay for higher education such as scholarships, grants, or employer-sponsored tuition.

2. Buying a Home
A mortgage is typically considered good debt.
Why? Homeownership builds equity, and property values generally appreciate over time.

• A recent mortgage industry report found that the average home equity for homeowners in the U.S. is about $193,000.
• In addition, mortgage interest rates have remained relatively low (around 7.1% for a 30-year fixed-rate mortgage) making home loans more affordable.

Before you buy a house

• Can you afford the monthly payment? (Less than 28% of your monthly income is recommended)
• Based on the price of the home, will it appreciate in value?
• Will you have to make significant investments to repair the home?

3. Starting or Expanding a Business
Ever heard this before: Sometimes you need money to make money?
Business loans can be a smart move if they lead to company growth and increased revenue.

• In 2023, the Small Business Administration issued $52 billion in loans to help start or expand businesses.

According to the Small Business Administration, businesses with adequate financing are better positioned to:

• Invest in resources
• Expand operations, and…
• Increase revenue

However, it’s crucial to have a solid business plan and a clear repayment strategy, if you plan to take out a business loan.
If you’re going to borrow money…education, real estate and growing a business are three of the most practical reasons to go into debt.

When Borrowing Doesn’t Make Sense

Not all debt is created equal—sometimes, borrowing money can do more harm than good.

Before you sign on the dotted line, here are three types of loans you may want to avoid.

1. Credit Card Debt
Credit card debt is one of the most expensive types of borrowing.

The average credit card interest rate in 2023 is around 22.8%, significantly higher than mortgage or student loan rates.

It’s also the highest credit-card interest rates have ever been. Here’s an example…

• If you only make the minimum payment on a $5,000 credit card balance, it would take you almost 30 years to pay it off, and cost about $10,000 in interest.

Racking up high-interest debt for non-essential purchases can lead to financial trouble.

• Americans owe over $1 trillion in credit card debt
• About 9% of people with credit card balances fail to pay, get flagged as delinquent, and transition to collections

Before you get a credit card

• What do you plan to use a credit card for (needs vs. wants)?
• What is the interest rate? Can you find a credit card with a lower interest rate?
• Can you pay the balance off every month?

3. Auto Loans for Expensive Cars
While an auto loan may be necessary, opting for a luxury vehicle beyond your means is not advisable.

• Cars depreciate rapidly, losing up to 20% of their value in the first year.
• The average car loan amount for new cars is $48,510 and $25,571 for used cars.
• The average monthly payment for a car loan is $735 for new cars and $523 for used cars.

While driving your dream car might be nice, it’s more financially prudent to buy a reliable, affordable vehicle.

Before you get a car loan

• Can you afford the car payment?
• How long will it take you to pay it off?
• What is the interest rate on the loan? Can you find a car loan with a better rate?
• Are you borrowing more than you need for a reliable car?

3. Payday Loans
Payday loans are extremely risky due to their exorbitant interest rates, which can exceed 400% APR.
Here’s an example:

• You get a $500 payday loan at the typical rate.
• Two weeks later the loan is due.
• You’ll owe about $576 or more.

Each state has its own regulations on payday loans. But many have limits on how much you can borrow, for a reason…

• These short-term loans often trap borrowers in a cycle of debt.
• Most lenders evaluate your income, debt, expenses and other factors before loaning you money. But with a payday lender, your ability to repay the loan while meeting your other financial obligations is generally not considered.

A vicious cycle of debt

Over 80% of payday loans are rolled over or followed by another loan within 30 days, according to the Consumer Financial Protection Bureau.

Before you get a payday loan

The Federal Trade Commission has filed hundreds of cases against payday loan lenders for:

• Engaging in deceptive advertising
• Using unfair billing practices
• Failing to comply with federal lending disclosure requirements
• Violating rules against wage assignment clauses and contracts
• Conditioning credit on the preauthorization of electronic fund transfers
• Employing unfair, deceptive, and abusive debt collection practices

Tip: If you really need a small loan for something, find an alternative to a payday loan.

Debt: Know what you’re getting into
Borrowing money might make sense for education, buying a home or building a business (at low interest rates). But it doesn’t for things like high-interest credit cards, luxury cars, or payday loans.

Thinking about taking out a loan or going into debt? Evaluate your financial situation to determine if it makes sense. If you’re not sure, get help from a finance professional to make informed decisions and avoid excessive debt.