Good Debt vs. Bad Debt

Is all debt bad? Not necessarily. The way you use borrowed money, the terms of your loans, and how these debts benefit you in the long run can determine whether your debt falls into the "good" or "bad" category.

What is good debt?

Good debt typically helps you achieve meaningful personal goals or leads to long-term financial gain.

For instance, taking out loans for law school might leave you with $100,000 in debt, but it could set you up for a rewarding and profitable career.

Common examples of good debt include:

• Mortgages: Help you build equity and wealth through home ownership

• Student loans: Finance education that can increase your earning potential

• Business loans: Allow you to start or grow a business that supports you and others

• Interest-free loans: For energy-efficient improvements or through nonprofit organizations

• Refinanced debt: Strategic moves that save money or make payments more manageable

What is bad debt?

Bad debt typically funds purchases that don't provide lasting value or comes with unfavorable terms.

Using loans for discretionary expenses like vacations or shopping often leads to significant interest charges with no long-term benefit.

Examples of bad debt include:

• Credit card debt: Often carries high interest rates when balances are carried month-to-month

• High-interest loans: Payday loans, auto title loans, or high-rate online installment loans

• Loans for discretionary spending: Borrowing for vacations, designer clothes, or hobbies

The grey area

Some debts aren't clearly good or bad. Credit card debt is typically considered bad, but if you pay your bill in full each month or use a 0% intro annual percentage rate (APR) offer responsibly, it can be beneficial.

Similarly, buy now, pay later plans and even car loans can fall into this middle ground depending on their terms and your specific situation.

How to avoid bad debt

You can take several approaches to avoid taking on harmful debt:

• Create and stick to a budget to identify unnecessary expenses

• Improve your credit score to qualify for better loan terms

• Build an emergency fund to cover unexpected expenses without borrowing

Getting out of debt

If you're struggling with debt, consider these steps:

1. Organize all your debts by amount, minimum payment, and interest rate

2. Compare strategies like the debt avalanche (highest interest first) or debt snowball (smallest balance first)

3. Set priorities and make necessary lifestyle adjustments

4. Seek support from financial counselors or assistance programs

5. Consider debt settlement or bankruptcy as last resorts if necessary

Making smart financial choices

Understanding the difference between good and bad debt helps you make smarter financial decisions. Good debt can be a tool that builds your financial future, while bad debt often drags you down.

The key is making intentional choices about when and how to borrow.

Ask yourself if the debt will help you build long-term value or if it's just funding immediate wants.