The Difference Between Good Debt and Bad Debt

You might be incredulous to the phrase “good debt.” A case can be made that there is no such thing as good debt, after all how can debt ever be good for anyone?

However, we live in a society where at least some forms of debt are necessary to make large, important purchases–unless you’re a millionaire. Assuming you are not a millionaire, and you will not be living separate from society, you will most likely take on some form of debt at some point in your life.

But when borrowing funds, it’s important to remember that there are still some types of debt that are bad for your personal finances. Allowing your debt to get out of control is never a good idea. If you want to stay on top of your finances, it’s important to learn about good debt, bad debt, and how to tell the difference between the two.

Typical Examples of Good Debt

Good debt can most easily be defined as debt that is used to purchase assets that can potentially increase your net worth. A few examples include:

  1. Education

This is a pretty obvious example of good debt. Even though student loans are getting more and more aggravating for college students in the United States, they are still widely considered good investments. Student loans don’t necessarily have to be used for a bachelor’s degree, as you could acquire one for technical or vocational schooling.

  1. Business

Entrepreneurship is one reason to take on a little bit of debt, since the end goal in mind is to create more income. By being in business for yourself, you could make more money, which makes the temporary debt worth it.

  1. Real Estate

Getting a mortgage to become a homeowner is a long-term investment in your future and therefore qualifies as good debt. Commercial and residential real estate for renting purposes can also be an excellent source of income.

Typical Examples of Bad Debt

Bad debt can most easily be defined as debts used to buy depreciating assets, or things that won’t add to your net worth or generate income. Here are some examples of bad debt:

  1. Credit Cards

Credit cards are typically used for purchases that don’t add any value to your personal finances. If this weren’t enough, the interest rates with credit cards can be outrageously high! High interest rates can lead you to be charged large amounts of money for very little benefit.

  1. Cars

Auto loans are extremely common but that doesn’t mean they’re good for your financial health. Cars, especially new ones, can cost a lot of money. But as soon as you drive the car off the lot, they start going down significantly in value! By buying a car with an auto loan, you start losing money even before the interest kicks in. Even though this is sometimes a necessary loan, it can’t really qualify as good debt.

Special Considerations are Sometimes Needed

So, what about exceptions? As mentioned above with auto loans, sometimes even when a debt isn’t good, it can be necessary. There may be times when emergencies pop up and you need funding, so you rely on credit cards, title loans, or other kinds of credit that classify as bad debt.

Bad debt won’t ruin your finances altogether. It all comes down to thoughtful decision making and doing what you can to pay off those bad debts as quickly as possible, so you don’t lose money on the interest rates.