Apr 19, 2024
Debt has been used for centuries . Merchants have relied on credit to buy the products they sold in their stores. People put goods on their account (or “tab”) in local grocery stores. Others used a retailer’s charge card to buy clothes or sought bank financing to buy a car or a house. For generations, debt has helped people reach personal and financial goals.
While it may seem simple to borrow money, it should be done thoughtfully; some loans may even support your goal to build wealth. A key step in your strategy is to know your financial situation and how much debt you can afford. Once you’ve figured that out, there could be various ways to combine tools like personal loans and long-term savings as part of your strategy.
It is important to know the different types of debt and credit that are available. Some types of loans might help your credit score. Other debt might harm your financial situation. For instance, payday loans, which are short-term loans with high interest rates, will not improve your credit score and could become very costly.
To help achieve your specific goals, here are several approaches you might want to consider:
Anytime you consider using debt, it is important to create a budget. Whether you are still in school, just starting out in a career, building a family, or saving for a home or retirement, one of the first steps in your plan is knowing how much debt you can take on.
“One thing you can always do to help reduce the chance of long-term harm from debt is have a plan,” said Sean T. Keating, a certified financial planner. “Know why you are taking on the debt. Know what you can possibly gain from taking it on. Most importantly, have a plan to how you are going to pay it back.”
Be sure to think about your tolerance for debt, which is the amount of debt you are comfortable taking on. To know your debt tolerance, identify how new debts and payments will affect your monthly budget based on your income.
Another important measure may be to calculate your debt-to-income (DTI) ratio, which compares the amount of money you owe with your overall income. It accounts for all monthly recurring debt and expenses, such as housing, credit cards, and other loans. Lenders may use your DTI as one measure of creditworthiness when assessing a loan application. You can use it to think about how comfortable you are with your current debt level, and what changes you might want or need to make.
A budget may also help you see ways to improve your financial picture—you might notice places where you spend less, for example. You might start with the 50/30/20 rule, which suggests you put 50% of your after-tax income toward paying expenses or “needs,” 30% to “wants,” and 20% to savings and building wealth.
A strong credit history may also help you reach important financial goals. Many people begin with a credit card. By using a credit card for purchases and then making on-time payments, you can start to build a credit history.
Typically, when you are first approved for a credit card, you receive a lower credit limit . Once lenders see that you’ve established a history of timely payments, they may increase the amount you can borrow. When your credit history shows that you have made your payments on time, you may be more likely to qualify for larger loans in the future, like an auto loan or a mortgage.
Secured credit cards are another option. For a secured card, you provide a refundable security deposit and receive a credit limit equal to that amount . In this way, it may help you build a credit history and show that you are responsible in the way you handle your finances.
When you borrow money and pay it back on the agreed-upon payment terms, it can be a reliable way to boost your credit score. A good credit score may help your financial picture by allowing you to borrow money at a lower interest rate, putting more money in your pocket over time.
One key to building your financial health is to recognize that some types of debt may be beneficial. Types of good debt may open possibilities for future income or an increase in value of something you own.
“It might seem contradictory to say debt can grow wealth,” Keating said. “It can, when it is used as leverage to help you attain, improve, or grow an income-producing asset.”
Most people take out a mortgage to buy a home. A mortgage might be considered good debt because real estate may increase in value over time. If your home becomes worth more than the amount you owe on your mortgage, you have gained equity, which might boost your net worth.
In addition, as you pay down your mortgage and build equity in your home, you may be able to take out a loan based on that equity to pay for larger-ticket items or expenses. There are different types of home equity loans available, including a traditional home equity loan and a home equity line of credit (HELOC).
Home equity loans typically have different options for borrowing. For example, Discover® offers lump-sum home equity options between $35,000 and $300,000.
Loans to consolidate debt may be another type of good debt that helps your financial situation. For example, personal loans may be used to consolidate higher-interest credit card debt, potentially lowering your monthly payments and saving you money over the long term.
When your monthly payments are lower, you might find you have extra money to make regular contributions to an online savings account. Some high-yield online savings accounts, like those at Discover, do not have a monthly fee or require a minimum deposit.
When you own a home, it is important to protect your investment. Over time, you may have unexpected repairs or want to renovate or make improvements. Some improvements may increase the value of your home and help provide a better return on those investments.
For instance, exterior improvement projects, like replacing your roof or installing new, energy-efficient windows , might provide a return on investment through energy savings. Interior projects , such as remodeling kitchens and bathrooms, may also boost the value of your home.
There are several different options available to finance home improvements. One good method might be to save money in advance of a home project. Depending on the size of your project, you could also consider a personal loan or a home equity loan, either of which may save you money on interest in comparison with a credit card.
A student loan to help pay for college, graduate school, or vocational training might also be considered another type of debt that could help you build wealth. Advanced education might help secure your future by expanding your job prospects and your lifetime income potential.
“Student loans can help you get the education you need to launch or advance your career, which can pay you a salary for the rest of your working life,” Keating said.
In general, people who have college degrees tend to be employed more and earn higher wages than those with high school degrees. But not all degrees are guaranteed to bring wealth. It can be complicated to balance a personal desire to study a chosen subject with the financial payoff of a college degree. Students might need to consider using a combination of financial aid, scholarships, and loan programs to fund college tuition and other education-related expenses.
Keep in mind that there are many ways to go into debt, especially with today’s online options. It is easy to apply for credit from many sources, whether remotely or in person.
You might want to consider the type of credit that would work best for you before deciding to apply. For example, it is important to understand the details, such as card credit limits, interest rates, annual percentage rate (APR), and possible fees.
After reviewing your options, you might find that a personal loan is the right choice as it can be used in several ways to help you reach financial goals. Whether saving money by consolidating debt from higher-interest credit cards or helping to pay for an important purchase or home renovation, a personal loan might be easier to budget for, with one set regular monthly payment.
Whatever your financial goals are, keep in mind that the right mix of borrowing and saving might help you achieve them. In fact, over 2 million people reached their goals with the help of a Discover personal loan.
To explore how a Discover personal loan might help you plan for your financial future, start by considering how much you need to borrow and what kind of monthly repayment you can afford. Our personal loan calculator can help you estimate monthly payments. There’s no commitment and no impact to your credit score.
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