Sam Explains: Understanding debt can help you keep your finances secure

Credit cards, student loans and mortgages are life-changing tools that afflict even the most level-headed and fall into the category of consumer debt. While debt can help expand opportunities, many people take on too much, putting a hefty burden on their finances. However, understanding how debt works can help prevent that and maintain a healthy grip on life.

While consumer debt has risen substantially in the U.S. with developments such as credit cards, it can be traced all the way back to the founding of the nation. After the Revolutionary War, U.S.public debt grew by more than $75 million and continued to grow until President Andrew Jackson eliminated all U.S. public debt in 1835. That number has since climbed and now is about $31 trillion. 

Public debt may be distant in the minds of most Americans, but these numbers shed light on the origins of debt in the U.S. After all, if the founders saw taking on debt as acceptable, why shouldn’t individual Americans?

This line of thinking is part of the issue of U.S. consumer debt. Many people do not see it as real due to its intangible nature and watch as politicians run up the bill for the nation, mimicking those actions in their own financials. However, debt exists for a reason, and when used correctly, it can benefit people in the long run.

The cost ofattending college in the U.S. has risen almost 180% in the last 20 years, outpacing the inflation rate by about 170%. Yet who among us has tens of thousands of dollars lying around to pay for an education? Enter debt in the form of student loans.

College graduates earn $2.8 million on average over the courses of their careers, compared to $1.6 million for high school graduates. The promise of self-betterment and increased income often draws people to take out loans.

That is the reason debt exists. Its purpose is to provide people with opportunities now that would not be possible otherwise.

While there are some who properly utilize debt for its intended purpose, there are others who misuse it to live beyond their means.

In 2008, the global economy collapsed. Everything looked bright for banks as more people were taking out mortgages on homes at subprime rates. These rates were higher, benefiting banks, but they carried more risk.

When people could not pay off their debts, the bubble burst, erasing more than $2 trillion from the global economy.

That serves as an example of how debt should not work. Banks were trying to exploit consumer debt by offering loans that looked good on the surface but were unstable at their roots. And in the same way, consumers were taking advantage of easy loans when they did not have the ability to take on that level of debt.

While these two examples demonstrate substantial amounts of debt, it is the smaller, everyday use of debt that usually makes or breaks financials.

There’s no doubt that Americans love their credit cards, evidenced by the $986 billion of debt they held in thefourth quarter of 2022, up about $61 billion from the previous quarter. Credit cards exist for the ease they provide, yet they are often misused, leading to people taking on more debt than they can afford.

The true problem is that around 56% of active cards carry a balance. Among that group, 46% take about a year or more to pay it off. Average credit card debt for individual cardholders across the U.S. ranges from around $5,400 in Kentucky to $9,400 in Connecticut.

The annual percentage rate for credit cards can range from 20% to 27%. If it takes someone more than a year to pay off a balance, the amount owed grows immensely. This is why credit card debt can cause financial ruin. The steep interest rates plus the principal due on the borrowed amount can be too much for some, leading to bankruptcy.

If you properly utilize debt through credit cards, you will have nothing to worry about. This is why they exist — if you need to buy groceries but do not have the cash on hand, you can borrow a small amount and pay it back later. Many people misuse credit cards and see them as “free money” in a way. But debt can be a useful tool if you pay off your balance and don’t try to live beyond your means.

Debt is a powerful instrument but also a double-edged sword. When used correctly, it provides a means of growth and improvement. When misused, it can lead to financial hardship, so be wise with your money. Use debt only when necessary, and be sure not to take on more than you can bear.