"All debt is bad" is common advice—but it's not quite accurate. While debt always comes with risk, some types of borrowing can actually help you build wealth over time, while others will almost certainly set you back.
Understanding the difference between good debt and bad debt helps you make smarter decisions about when borrowing makes sense and when it doesn't.
What Makes Debt "Good" or "Bad"?
The distinction comes down to one question: Does this debt help you build wealth or increase your earning potential?
| Good Debt | Bad Debt |
|---|---|
| Finances appreciating assets | Finances depreciating assets or consumption |
| Has potential to increase net worth | Decreases net worth |
| Often has low interest rates | Typically has high interest rates |
| Usually has tax advantages | Rarely has tax benefits |
| Strategic and planned | Often impulsive or avoidable |
💡 Pro Tip: Even "good" debt is only good if you can afford the payments and have a plan to pay it off. Unaffordable debt is always bad debt.
Examples of Good Debt
Mortgage (Home Loan)
A mortgage lets you buy an asset that typically appreciates over time while building equity with each payment.
Why it can be good debt:
- Home values historically increase (3-4% annually on average)
- Mortgage interest may be tax-deductible
- Fixed monthly payment while rent would increase
- Builds equity that becomes part of your net worth
- Typically low interest rates (5-7% in most markets)
When it becomes problematic:
- Buying more house than you can afford
- Interest-only or adjustable-rate mortgages you don't understand
- Buying in a declining market with plans to sell quickly
- Using your home as an ATM through excessive refinancing
📌 Key Takeaway: A mortgage is good debt when the home is affordable (28% or less of gross income) and you plan to stay long enough to build equity.
Student Loans
Student loans can be good debt when the education significantly increases your earning potential.
Why they can be good debt:
- College graduates earn roughly $1 million more over their lifetime than non-graduates
- Opens doors to higher-paying careers
- Federal loans have low fixed rates and flexible repayment options
- Interest may be tax-deductible (up to $2,500/year)
When they become problematic:
- Borrowing more than your expected first-year salary
- Attending expensive schools when affordable options exist
- Degrees with limited job prospects relative to cost
- Private loans at high interest rates
⚠️ Warning: Student loans are only "good" if your education leads to increased earning potential. A $100,000 degree for a $35,000 career is not good debt.
Business Loans
Borrowing to start or grow a business can generate returns far exceeding the interest cost.
Why it can be good debt:
- Provides capital to generate income
- Business interest is often tax-deductible
- Potential returns can dwarf interest costs
- Allows growth that wouldn't be possible otherwise
When it becomes problematic:
- Borrowing for an unvalidated business idea
- Personal guarantees on high-risk ventures
- Using high-interest sources (credit cards, merchant advances)
- Borrowing more than the business can realistically repay
Investment Property Loans
Loans for rental properties can generate passive income and appreciation.
Why they can be good debt:
- Property generates rental income
- Real estate typically appreciates
- Interest and expenses are tax-deductible
- Builds equity over time
When they become problematic:
- Negative cash flow properties
- Over-leveraging with multiple properties
- Variable-rate loans in rising rate environments
- Markets with declining property values
Examples of Bad Debt
Credit Card Debt (Carried Balances)
Credit card debt for consumption is almost always bad debt.
Why it's bad:
- Interest rates of 18-28% APR
- Finances things that lose value immediately
- Compounds quickly if only paying minimums
- No tax benefits
- Easy to accumulate unconsciously
The numbers:
| Balance | APR | Minimum Payment | Time to Pay Off | Total Paid |
|---|---|---|---|---|
| $5,000 | 20% | $100/month | 9+ years | $10,800+ |
| $10,000 | 22% | $200/month | 9+ years | $21,500+ |
📌 Key Takeaway: Paying only minimums on credit card debt means paying more than double what you originally borrowed. This is wealth destruction.
Auto Loans (Especially on New Cars)
Cars depreciate 20-30% in the first year alone. Financing a depreciating asset is generally bad debt.
Why it's often bad:
- Asset loses value while you pay interest
- Encourages buying more car than needed
- Can end up "underwater" (owing more than car is worth)
- Typical rates of 5-10%+ for average credit
When it might be acceptable:
- Reliable transportation needed for work
- Low interest rate (under 4%)
- Reasonable loan amount relative to income
- Used car with lower depreciation
💡 Pro Tip: If you must finance a car, buy used (2-3 years old), keep the loan under 48 months, and put at least 20% down to avoid going underwater.
Payday Loans and Title Loans
These are universally bad debt with predatory terms.
Why they're terrible:
- APRs of 400%+ when annualized
- Designed to trap borrowers in cycles
- Extremely short repayment terms
- Often lead to repeat borrowing
The math:
A $500 payday loan with $75 fee for two weeks = 391% APR
Personal Loans for Consumption
Borrowing for vacations, weddings, or lifestyle purchases is typically bad debt.
Why it's problematic:
- Finances experiences/items with no lasting value
- Interest rates of 8-20%+ depending on credit
- Payments last longer than the enjoyment
- Indicates spending beyond means
Buy Now, Pay Later (BNPL) for Non-Essentials
While often marketed as "interest-free," BNPL encourages overspending.
Why it can be problematic:
- Encourages impulse purchases
- Late payments trigger fees and interest
- Multiple BNPL balances become hard to track
- Doesn't build credit (but can hurt it if missed)
The Gray Areas
Some debt falls between clearly good and clearly bad.
Medical Debt
- Not by choice: Medical emergencies aren't optional
- Can be necessary: Health is prerequisite to earning income
- Strategy: Negotiate bills, set up payment plans, avoid putting on credit cards
Consolidation Loans
- Can be good: If it lowers interest rates and you don't rack up new debt
- Can be bad: If it just frees up credit cards to spend more
- Key: Close the cards you consolidate or commit to not using them
Home Equity Loans
- Good use: Home improvements that increase property value
- Bad use: Vacations, cars, or consumption
- Risk: Your home is collateral—default means losing your house
Questions to Ask Before Borrowing
Before taking on any debt, ask yourself:
- Will this increase my net worth or earning potential?
- Can I comfortably afford the payments?
- What's the interest rate, and is it reasonable?
- Is there a cheaper way to achieve this goal?
- What happens if my income decreases?
- Am I borrowing for an asset or for consumption?
If the answers don't clearly support borrowing, reconsider.
Managing Your Debt Mix
If You Have Good Debt
- Make payments on time—it builds credit
- Consider paying extra if rates are high
- Don't rush to pay off low-rate debt at expense of investing
- Review periodically (refinance opportunities, etc.)
If You Have Bad Debt
- Stop adding to it immediately
- Create a payoff plan (avalanche or snowball method)
- Consider balance transfers or consolidation for lower rates
- Build an emergency fund to avoid future bad debt
Ideal Debt Profile
- Primary residence mortgage (if affordable)
- Limited student loans with good ROI
- No credit card balances carried month-to-month
- No payday, title, or high-interest personal loans
The Bottom Line
Debt is a tool. Like any tool, it can build something valuable or cause damage—depending on how you use it.
Good debt helps you acquire assets that appreciate, increase your income, or provide essential stability. It has manageable interest rates and clear payoff timelines.
Bad debt finances consumption, depreciates immediately, carries high interest rates, and keeps you trapped in payment cycles.
Before borrowing, always ask: "Will this money work for me, or will I be working for this money?"