Good Debt vs Bad Debt: The Main Differences You Should Know

Photo by Ruth Enyedi

The kind of debt you have can affect your credit score, interest rates, and more. It’s important to know the difference between good debt vs bad debt so you can be in the best financial position possible.

A credit card can be bad debt, for example, if you rack up high balances and miss payments. A credit card can also be good debt if you pay it off and accumulate rewards points.

We’ve rounded up examples of good debt and bad debt to help you decipher the difference. Here’s everything you need to know about the types of debt and what to do if you have more than you can handle.

What Is Considered Debt?

To put it simply, debt is an amount of money you borrow to pay back on a future date. This money is borrowed from one person to another, from an entity such as a bank, an online lender, a school, or a retailer.

Interest is typically charged until the debt is paid in full. The loan terms and interest charges are what can make debt good or bad.

When you have too much debt, you can look into the best consolidation companies to help you streamline your debt into one affordable payment with a lower interest rate.

What Is Good Debt?

A low-interest debt that helps to increase your net worth or income is good debt. Even if you have good debt, it’s important to remember that having too much can cause you to cross the line.

Medical debt is an example of a low interest or sometimes zero interest debt. This debt is usually unavoidable and although you may not pay interest, you might have more than you can pay comfortably.

Student loans are considered good debt. This is an investment in yourself and your future career. Federal loans, in particular, have low-interest rates.

Mortgages are another example of good debt. This debt helps to increase your net worth. A mortgage can also lead to income on a rental property, for example.

Car loans are also considered good debt. You likely need your car to get to work and live your life. Car loans can turn into bad debt if you get in over your head.

What Is Bad Debt?

Bad debt is a loan that drags you down financially. It costs you more than the debt is worth and it doesn’t increase your net worth. Often times a bad debt can come from good debt that isn’t properly managed.

Credit cards can be great for accumulating rewards and increasing your credit score. If you have large balances or defaults, however, these can cost you a lot of money.

Personal loans used for non-essentials can also turn into bad debt. These often come with high-interest rates and unfavorable terms. Things like clothes and expensive vacations should never warrant a personal loan.

Good Debt vs Bad Debt: How to Get Above Water

If you find yourself drowning in debt, don’t panic. There are some effective ways you can reduce your debt. Start by paying off any small debts you have. It will feel great to conquer the low hanging fruit first.

You should then make a plan to tackle your most expensive debt. Stop using your credit card, for example, and make your payments automatic.

Knowing the difference between good debt vs bad debt is a great place to start when it comes to healthy finances. For more personal finance tips, visit the blog section for resources and news.

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