"Good" Debt vs. "Bad" Debt: What Is the Difference?
"Debt" can feel like it's a bad word, but the word merely describes a simple financial transaction: borrowing money to buy something today and then pay for it later.
Debt has important uses in life, whether it's buying a home (a mortgage loan) or being able to pay the auto mechanic when your car suddenly dies on the side of the road (a credit card). Debt also helps businesses get off the ground — by providing start-up capital the business owner might not have, in the form of a business loan — and often helps people pay for higher education, with student loans.
So there is such a thing as "good" debt. And yes, bad, debt, too. But whether debt is good or bad is dependent on each individual's needs and circumstances and why they are borrowing money. In the past, debt was broadly broken into the following simplified categories:
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"Good" debt is debt that has the potential to increase your net worth or improve and enhance your life in a meaningful, long-term way
- Mortgages, student loans, business loans, home-improvement loans
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"Bad" debt is debt that pays for immediately consumable items that lose their value shortly after purchase
- Credit card purchases not paid off in full each month, payday loans, personal loans for expendable items (vacations, weddings etc.)
In this scenario, debt that creates wealth or increases in value over time is considered "good" debt and debt that depreciates over time is "bad" debt.
But over the past decades things have changed: homes no longer automatically appreciate over time, and college degrees no longer guarantee the graduate will be earning at a significantly higher level than without the degree.
So whether debt is "good" or "bad" actually refers to how it's managed and maintained. Good debt is debt you undertake for a specific purpose with a clear timeline for repayment, whether it's a 30-year-mortgage or a $3,500 credit card charge you made for a major purchase and intend to pay off in 4 to 6 months. Debt is more about the value you gain for taking on the debt — being able to live in a house you are still paying for, or being able to furnish that house without waiting for months to save for the furniture — than the specific item purchased.
But debt should always be entered into with a clear plan for its use. When you become unable to manage any or all of your debts — whether your mortgage or your credit cards — then the debt becomes problematic and can require a lot of energy and stress and time to manage it and pay it off. In the case of credit card debt, late fees and penalty payments are added to the original debt, and the debt begins to snowball. This is often a time to consider pursuing a specific solution to manage and resolve your debt. And this is when we start to understand that certain kinds of debt can be "bad."
Careful consideration of what debt you choose to take on is always advised, and it is especially wise to take a long view. Will the item you are purchasing with your credit create a long-term improvement to your life? Do you have a clear payment plan? In the end, good debt is debt you can afford; and bad debt is that which you can't afford. So enter into credit agreements and debt with careful planning.