After dropping below $800 million at the start of the coronavirus pandemic, the total aggregate credit card balance in the U.S. soared to nearly one trillion dollars as of the end of March this year, according to the Federal Reserve Bank of New York. That’s a new record high and does not bode well for Americans’ balance sheets. Part of the problem is that we consumers were never taught in school how to manage debt safely. It can be done, but in my experience only if you follow certain rules.

Rule #1: Avoid borrowing money for non-appreciating assets.

Real estate, stocks, and bonds are examples of assets that generally increase in value (i.e. appreciate) over time. Commodities such as industrial metals and energy products, as well as artworks, jewelry, and other collectables, may see either appreciation or depreciation depending on varying supply and demand. Just about all other household items – cars, furniture, clothing, appliances, electronics, etc. – decline in value after purchase generally due to advances in production that enable the creation of lower-priced or better-performing substitutes in the future. 

Why is it a problem to borrow money to pay for a depreciating asset? Because you cannot utilize the asset to help defray the cost of the loan should an unforeseen circumstance arise. Suppose you are holding a car loan that is halfway paid off. The amount owed at that point is likely to be more than the current value of the car. If you were to lose your job or encounter unexpected healthcare expenses, selling the car would not help. You’d still be in debt.

Is it safe to use credit cards to pay for household items? Yes, but only if you pay off the balance in full every month. Otherwise those items may end up costing you a lot more than you expected or can afford.

I would consider fifteen and thirty-year home mortgages generally to be safe since home prices rarely decline or remain depressed for such long periods. I would not recommend borrowing money to invest in stocks and bonds, however. Although their prices historically increase in value long-term, they can fluctuate pretty wildly over the short-term. Excessive leverage is one of the factors that destroyed Lehman Brothers in 2008.

I am often asked about student debt and how it relates to this rule. When you incur student debt, you are in effect investing in yourself. And you are (hopefully) an appreciating asset! Most students’ net worth twenty years after graduation is higher than it was when they were in school. Therefore student debt is a perfectly acceptable way of financing higher education. That is, as long as you also follow the next rule.

Rule #2: Avoid borrowing money without having a well-thought out plan to pay it back.

This is where some of the biggest borrowing mistakes are made. When applying for a home mortgage, do you borrow the maximum amount the lender offers to provide you? Or instead do you first create a financial plan that includes expectations of income and expenses over the next thirty years? By limiting the amount to be borrowed based on your anticipated ability to maintain the payments, you can avoid the likelihood of becoming house poor now and/or possibly having to sell the house at a loss in the future.  

Borrowing for college also requires careful planning.  How much student debt can you truly afford? Estimating the income you can get from a particular career, both initially and over time, can be valuable in determining the maximum debt to safely incur for your education.

For most everything else, if you have to borrow to buy it, then you probably can’t afford it. Consider a cheaper alternative for which you can pay cash. Always remember that debt is not free money. You may face difficult times in your life when you have no choice other than to borrow money in order to stay alive. But for the most part, managing debt is simply about making realistic decisions about what you can and cannot afford. If you follow just these two simple principles, you will protect yourself from having debt overwhelm your lifestyle.