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“All debt is bad” is one of the most common pieces of financial advice — and it’s wrong.
Not all debt is created equal. Some debt can actually help you build wealth, increase your earning power, and create financial opportunities that wouldn’t exist otherwise. Other debt does nothing but drain your money through interest charges and keep you trapped in a cycle of paycheck-to-paycheck living.
Understanding the difference between good debt vs bad debt was a turning point in my financial education. For years, I treated all borrowing the same — as something to feel guilty about. But once I understood that debt is a tool, and that tools can be used wisely or recklessly, my entire perspective shifted. The goal isn’t to avoid all debt at any cost. It’s to use debt strategically when it builds your future, and eliminate it ruthlessly 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 over time?
Good debt is borrowing that finances something likely to increase in value or generate income that exceeds the cost of the debt. It’s an investment in your future that pays for itself — and then some.
Bad debt is borrowing that finances things that lose value immediately or generate no return. It costs you money without building anything. It’s consumption disguised as spending power.
There’s also a gray area — debt that could be good or bad depending on how it’s managed. The key is understanding where each type of debt falls and making informed decisions rather than emotional ones.
Examples of Good Debt
Mortgages
A mortgage is often considered the most common form of good debt. You’re borrowing money to purchase an asset — your home — that historically appreciates in value over time. Meanwhile, you’re building equity with every payment instead of paying rent with nothing to show for it.
A $300,000 home purchased with a mortgage at 6.5% will cost you significant interest over 30 years. But if the property appreciates at the historical average of 3% to 4% per year, the home could be worth $700,000 or more by the time the mortgage is paid off. The debt cost you money, but the asset it purchased earned you far more.
That said, a mortgage only qualifies as good debt if it’s affordable. Buying more house than you can comfortably afford — stretching your debt-to-income ratio to the breaking point — turns good debt into a financial trap.
Student Loans (With Caveats)
Student loans can be good debt when they finance education that significantly increases your earning potential. A degree in engineering, nursing, computer science, or other high-demand fields often leads to higher lifetime earnings that far exceed the cost of the loan.
However, not all student debt is good debt. Borrowing $100,000 for a degree with limited job prospects or low average salaries may not generate enough return to justify the cost. The key factors are: the field of study, the total amount borrowed, and the realistic earning potential after graduation.
Federal student loans are generally more favorable than private loans due to lower interest rates, income-driven repayment options, and potential forgiveness programs.
Business Loans
Borrowing to start or grow a business that generates revenue can be one of the highest-return uses of debt. A $20,000 business loan that helps you launch a venture earning $50,000 per year in profit is clearly good debt.
The risk, of course, is that not every business succeeds. Business debt only qualifies as “good” if the business generates enough revenue to service the debt and produce a profit. This makes business debt higher-risk than a mortgage or education, but also potentially higher-reward.
Examples of Bad Debt
Credit Card Debt
Credit card debt is almost always bad debt. The items you purchase with a credit card — meals, clothing, electronics, entertainment — typically lose value immediately or have no lasting financial value at all. Meanwhile, you’re paying 20% to 28% APR on those purchases if you carry a balance.
I learned this the hard way during my university years, as I’ve written about in my credit card tips for beginners guide. I was buying things I didn’t need with money I didn’t have, then paying interest that made everything cost even more.
The exception is using a credit card strategically — earning cashback or rewards on purchases you’d make anyway, and paying the balance in full every month. In that case, you’re not actually carrying debt; you’re using the card as a payment tool.
Payday Loans
Payday loans are the most expensive form of debt available to consumers. They charge fees that translate to annual interest rates of 300% to 500% or more. A $500 payday loan might cost you $575 to repay in two weeks — and if you can’t, the fees compound rapidly.
Payday loans are designed to trap borrowers in a cycle of re-borrowing. They should be avoided at virtually all costs. If you’re in a situation where a payday loan feels necessary, explore every alternative first: personal loans from a credit union, borrowing from family, selling items, or negotiating payment plans with the creditor you need to pay.
Auto Loans (Often Bad Debt)
This one surprises people. A car is a depreciating asset — it loses value the moment you drive it off the lot and continues losing value every year. Borrowing money to buy something that’s guaranteed to be worth less tomorrow is, by definition, not an investment.
That doesn’t mean you should never finance a car. Many people need reliable transportation to earn a living. But it means you should minimize auto debt as much as possible: buy a reliable used car instead of a new one, make the largest down payment you can, choose the shortest loan term you can afford, and avoid financing extras like extended warranties and gap insurance unless genuinely needed.
A $35,000 new car financed at 7% for 6 years will cost you nearly $43,000 after interest — for an asset that might be worth $15,000 by the time it’s paid off. That’s $28,000 in lost value and interest.
Personal Loans for Consumption
Borrowing money for vacations, weddings, furniture, or other lifestyle expenses is bad debt. These purchases don’t generate income or appreciate in value. You’re committing future income to pay for present consumption — plus interest.
If you can’t afford something with cash, the financially responsible approach is to save for it. Use the budgeting strategies I outline in my how to budget and save money for beginners guide to set money aside for larger purchases over time.
The Gray Area: Debt That Could Go Either Way
The good debt vs bad debt distinction isn’t always clear-cut — some borrowing falls in between. Some types of debt don’t fit neatly into “good” or “bad” — their classification depends on the specifics:
Home equity loans. Borrowing against your home’s equity to fund home improvements that increase property value? Potentially good debt. Borrowing against equity to fund a vacation? Bad debt using your home as collateral, which is worse than a regular personal loan.
Consolidation loans. Combining multiple high-interest debts into a single lower-interest loan can be a smart move if it reduces your total interest cost and you don’t accumulate new debt afterward. But if consolidation just frees up credit cards that you then max out again, it makes things worse.
Medical debt. Nobody chooses to have a medical emergency. Medical debt is unfortunate rather than irresponsible. If you’re facing medical bills, negotiate with the provider, ask about payment plans, and explore financial assistance programs before putting charges on a credit card.
How to Use Debt Strategically
Understanding good debt vs bad debt isn’t about avoiding all borrowing — it’s about borrowing with intention:
Always ask: does this debt build my future? If the answer is yes — financing education, buying a home, investing in a business — it may be worth the cost. If the answer is no — financing lifestyle, impulse purchases, or depreciating assets — find another way.
Minimize interest costs. Even good debt should be managed efficiently. Shop for the lowest rates, make extra payments when possible, and choose fixed rates for long-term debt to protect against rising rates. Understanding how interest works is crucial — read my understanding interest rates guide for a deep dive.
Never let good debt become bad debt. A mortgage is good debt — until you refinance it repeatedly to pull out equity for spending. Student loans are good debt — until you borrow far more than your expected income can support. The line between good and bad can shift based on how you manage it.
Eliminate bad debt as fast as possible. High-interest consumer debt — especially credit cards and payday loans — should be paid off aggressively. Every dollar of interest you pay on bad debt is a dollar that could be building your wealth instead.
Maintain a healthy debt-to-income ratio. Lenders use your debt-to-income ratio (monthly debt payments divided by monthly gross income) to assess your borrowing capacity. Most financial advisors recommend keeping this ratio below 36%, with no more than 28% going to housing.
Once you understand good debt vs bad debt, every borrowing decision becomes clearer.
The Debt-Free Trap: When Avoiding All Debt Hurts You
There’s a popular movement advocating for zero debt under all circumstances. While the intention is good — nobody should drown in debt — the execution can actually hold you back.
A person who refuses all debt, including a mortgage, may spend decades renting while housing prices rise. A person who avoids student loans entirely may miss educational opportunities that would significantly increase their lifetime earnings. A person who never uses a credit card has no credit history, which can make renting, getting insurance, and even getting hired more difficult.
The financially literate approach isn’t to avoid debt entirely — it’s to understand the difference between debt that builds your future and debt that mortgages it. Use the first type strategically. Avoid the second type completely.
For a comprehensive understanding of these financial principles, read my complete financial literacy for beginners guide.
Frequently Asked Questions
Is all credit card debt bad?
Carrying a balance on a credit card — where you’re paying interest — is almost always bad debt. However, using a credit card for everyday purchases and paying the full balance each month isn’t really “debt” in the traditional sense. You’re using the card as a payment tool, potentially earning rewards, and paying zero interest.
Are student loans good debt or bad debt?
It depends on the degree, the amount borrowed, and the career prospects. Student loans that finance education with strong earning potential in a high-demand field are generally good debt. Excessive borrowing for degrees with limited job prospects can become bad debt. The key is to borrow the minimum necessary and have realistic expectations about post-graduation income.
Should I pay off my mortgage early?
Not necessarily. If your mortgage has a low interest rate (below 5-6%) and you’re investing the extra money in assets that historically return more (like index funds averaging 7-10%), you may build more wealth by investing rather than paying off the mortgage early. However, the peace of mind of owning your home outright has real value that’s hard to quantify.
How do I know if I have too much debt?
Calculate your debt-to-income ratio: divide your total monthly debt payments by your monthly gross income. Below 36% is generally considered healthy. Above 43% is concerning and may make it difficult to qualify for new credit. If debt payments are causing you to miss other financial goals — saving, investing, or covering basic needs — you have too much debt regardless of the ratio.
What’s the fastest way to pay off bad debt?
Two proven methods: the avalanche method (pay minimums on everything, put extra money toward the highest-interest debt first — saves the most money) or the snowball method (pay minimums on everything, put extra money toward the smallest balance first — provides psychological wins). Both work. The best method is whichever one you’ll stick with.
The Bottom Line
The difference between good debt vs bad debt comes down to whether borrowing builds your future or borrows from it. Strategic debt — like a mortgage, education loans, or business financing — can accelerate your financial growth. Consumer debt — like credit card balances, payday loans, and lifestyle financing — does nothing but cost you money.
Learn to distinguish between the two, use good debt wisely, eliminate bad debt ruthlessly, and you’ll be far ahead of people who either fear all debt or accept all debt without question.
Toyin Onagoruwa is the founding editor of BrokeMeNot. With over five years of experience in personal finance writing and a background in financial services, he helps everyday people navigate credit cards, budgeting, and smart money management. Connect with him on LinkedIn.