animated scale with house on right scale and credit card on left scale

Good debt vs. bad debt

Aug 11, 2020
Empower Insights

Not all debts (or interest rates) are created equal

American consumer debt today sits at almost $14 trillion.[1] It’s a staggering number, but not all debt is to be feared.

Good debt is debt in service of a longer term goal. For example, many people use a mortgage to buy a home or take out student loans to pay for college. Both may be hefty debts, but you can expect each to pay off in its own way. They’re also likely to have relatively low interest rates, making repayment manageable.

Bad debt, on the other hand, is debt you owe on depreciating assets—things that lose value over time. It can also be debt on discretionary expenses, like vacations and restaurant meals. In most cases, bad debt comes with high interest rates, often from credit card spending. 

Regardless of which type of debt you have, it’s important to understand your interest rate and have a realistic repayment plan.

Typical interest rates for different types of debt2:

  • 30-year fixed-rate mortgage : 3.7 – 4.5%3
  • New car loan: 4.5 – 5.2%4
  • Federal student loan: 4.5 - 7%5
  • Credit cards (good credit score): 15.59% - 24.13%6

In most cases, your credit score helps determine the interest rate that a lender offers you. Your credit score is based on several factors, including your payment history and how much debt you already have.

animated image with Credit report, credit card and calculator

Range of credit scores7

  • Above 800 – Exceptional
  • 740 – 799 – Very good
  • 670 – 739 – Good
  • 580 – 669 – Fair
  • Below 580 – Poor

Paying off a good debt: A $160,000 mortgage8

  • 30-year mortgage with a 3.75% fixed interest rate
    • Monthly payment (principal and interest): $741
    • Total interest paid: $106,755
  • 15-year mortgage with a 3.25% fixed interest rate
    •  Monthly payment (principal and interest): $1,124
    • Total interest paid: $42,369

Paying off a bad debt: A $5,000 balance on a credit card with 18% APR

  • Making minimum payments only (3% of your balance)9
    • Monthly payment: $150 the first month, less each month thereafter
    • Time to pay off: More than 16 years
    • Total paid: $9,698.44
  • Paying more than the minimum10
    • Monthly payment: $200
    • Time to pay off: Less than three years
    • Total paid: $6,313

 

Consider an Empower Investment Account to save for bigger purchases

1 Federal Reserve Bank of New York, https://www.newyorkfed.org/microeconomics/hhdc.html, April 2020.

2 As of January 2020.

3 Freddie Mac, http://www.freddiemac.com/pmms/, July 2020.

4 Bankrate, https://www.bankrate.com/loans/auto-loans/current-auto-loan-interest-rates/, July 2020.

5 U.S. Department of Education, https://studentaid.gov/understand-aid/types/loans/interest-rates, July 2020.

6 US News & World Report, https://creditcards.usnews.com/articles/average-apr, June 2020.

7 Bankrate, https://www.bankrate.com/mortgages/how-your-credit-score-affects-your-mortgage-rate/, November, 2019.

8 Bankrate, https://www.bankrate.com/calculators/mortgages/amortization-calculator.aspx, July 2020.

9 Bankrate, https://www.bankrate.com/calculators/credit-cards/credit-card-minimum-payment.aspx, July 2020.

10 Bankrate, https://www.bankrate.com/calculators/credit-cards/credit-card-payoff-calculator.aspx, July 2020.

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