Good Debt vs. Bad Debt
Many people focus on getting out of debt, but not all debt is harmful. Some types of borrowing could actually help you reach your financial goals. The trick is to know what's good debt vs. bad debt, how each type affects your credit history, and how to pay off bad debt.
What is good debt?
Good debt is any loan that helps you build long-term financial value. It can strengthen your credit history, open doors to higher income, or grow your assets over time.
💡 Tip: Good debt should feel manageable and purposeful, meaning it moves you closer to your financial goals.
Examples of good debt
- Mortgages: Buying a home with a mortgage can help you build equity and long-term wealth. Over time, your property’s value may grow, allowing you to sell at a profit or generate rental income.
- Home equity loans: Borrowing against your home's value through a loan or line of credit works well when used for upgrades or repairs that boost your home's worth. Just make sure you can comfortably manage the added payments.
- Student loans: Education is an investment in your future. Student loans can open the door to higher-paying career opportunities, but it’s important to consider the earning potential of your chosen field before borrowing.
- Small business loans: A business loan can help turn a great idea into a profitable venture. With a strong plan and clear goals, this kind of debt can lead to long-term financial growth and independence.
➢ RELATED: 7 Reasons to Get a Personal Loan
What is bad debt?
Bad debt typically funds items that lose value or don't provide a long-term benefit. It can drain your finances and limit your flexibility.
But even bad debt, when used responsibly, can help you stay on track and build credit over time.
Examples of bad debt
- Credit card debt: Credit cards can help build your credit history, but carrying a balance month to month leads to excess interest charges that can keep you in debt. Paying off your balance in full whenever possible helps you avoid growing costs.
- Car loans: Vehicles lose value quickly, so car loans often cost more than the car is worth. Still, financing a car is often necessary to get to work or school. When you need to borrow, choose an affordable vehicle and loan amount you can comfortably repay.
- Loans for non-essentials: Borrowing for luxuries like travel, entertainment, or upgrades such as a hot tub may feel rewarding in the moment, but it can strain your budget later. If the purchase isn't essential or doesn't add lasting value, consider saving up instead
➢ RELATED: Is It Something You Need? Or Something You Want?
What determines if a debt is good or bad?
Whether a debt is considered good or bad depends on several factors, including how it affects your finances over time and what you’re borrowing the money for. Before taking on new debt, consider these points:
- Purpose of the loan: Borrowing for something that grows in value — like education or a home — can help build long-term wealth.
- Interest rate: Lower interest rates typically make a loan more manageable and less costly. Higher rates, such as those attached to credit cards, can make it harder to get ahead.
- Repayment term: Shorter repayment periods mean you’ll pay less interest overall, while longer terms may increase the total cost of borrowing.
- Affordability: Any loan becomes bad debt if it stretches your budget or causes you to miss other payments. Only borrow what fits comfortably within your monthly income.
- Potential return: Some debts, such as student loans or small business financing, may lead to future earnings or opportunities that outweigh the cost of borrowing.
A good debt helps you move closer to your goals, while bad debt limits your financial flexibility or peace of mind.
How to pay down your debt
If you want to pay down debt, or get out of debt altogether, start with your bad debts. Here's how to approach debt repayment when you have a mix of good and bad debts:
1. Figure out how much you owe
The first step is to take stock of what you owe. List your total balances, monthly payments, and interest rates to help you prioritize debts.
2. Prioritize highest-interest debts
High-interest debts cost you more over time. In addition to making regular monthly payments, put extra toward your highest-interest debt until it's paid off. Then move to the next-highest, and so on."
3. Cut back on non-essential spending
While paying down debt, cut back on non-essential purchases like clothing and other splurges. Redirect those funds toward your debt instead.
4. Keep paid-off accounts open
Once you've repaid a debt, keep the account open. It helps your credit score by lowering your credit utilization ratio and preserving the length of your credit history. Store the card at home instead of in your wallet if you're worried about overspending.
💡 Tip: Understanding the difference between good and bad debt helps you create a debt-repayment plan that supports your goals while building a stronger financial future.
More on debt management:
Notice: Information provided in this article is for informational purposes only. Consult your attorney or financial advisor about your financial circumstances.
About the author
Bree Ewers is a senior editor, copywriter, and content writer whose work has been featured across the media, small business, and financial industries. She operates Nomad Freelance Content from her home office in Portland, Oregon.
