The Difference Between Good Debt and Bad Debt

woman looking at bills for good and bad debt

Money experts and financial gurus frequently talk about avoiding "bad debt" and only taking on "good debt." There are even some outspoken experts who think all debt is "bad."

What makes one debt acceptable, but another debt not so appealing? And why may the whole good debt/bad debt difference be not so cut-and-dry anyway?

Here's what you need to know about debt.

 


"Good" Debt

Good debt can be described as debt that is used for things that appreciate in value or generate income. Some examples are:

  • A mortgage because real estate tends to increase in value over time;
  • A business loan because it can help a business owner grow their business and increase profits;
  • A student loan because a college education can help you earn more money when you graduate.

"Bad" Debt

On the other hand, bad debt is debt you've gone into to pay for something that will depreciate in value. This could mean the debt you incurred paying for things like vacations, consumables like clothes and meals out, or experiences that will never increase in monetary value or earn you income. Even a car could be considered a "bad debt," because an automobile loses value the moment you drive it off the lot.

The Truth About Any Debt

In reality, the difference between "good" debt and "bad" debt is not as clear cut as we've laid out above. For example, we just said "good debt" would be a mortgage. But if you got a mortgage with a high interest rate and the bottom drops out of the real estate market just as you lose your job, you certainly don't have a good debt on your hands. 

What if you incurred debt for a college degree, but jobs in your area of study don't even begin to cover your monthly loan obligation? The resulting student loan payments will not feel like good debt either.

The same goes for "bad debt." Many people use credit cards to pay for food, gas, clothing, and other consumables they need on a daily basis, and take out loans to buy automobiles. You can't go without food, fuel, or clothing, and most Americans need cars to get to their jobs and take care of their daily needs. You could pay cash for everything, but maybe you earn points on the credit card you pay in full each month or you don't have $35,000 in cash to pay for a car. How can this debt be "bad"?

This shows you there are other factors to consider besides appreciation and depreciation in determining if debt is "good" or "bad."

A better way to think about good debt and bad debt may be to look at your debts this way: any debt can be bad, whether it's a mortgage payment, a car loan, or a credit card bill if it causes you to struggle with your finances. If you can easily pay your mortgage, car loan, and credit card bills in full each month, leaving enough money for savings and all your other living expenses, your debt situation is good.

 

Ready to get a better grip on your debt? We'll show you how! Download our free Financial First Aid guide today!

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