Good debt vs bad debt: a useful (but leaky) distinction
Some debt builds an asset. Some just buys depreciation. Know which you're taking on.
Last reviewed: · Reviewed by the Money Scale editorial team
'Good debt' typically means borrowing to acquire something that grows in value or earning power: a mortgage on a reasonable home, federal student loans for a high-ROI degree, a small-business loan. 'Bad debt' funds consumption: credit-card balances, payday loans, financed depreciating cars.
≤ 36%
Total debt-to-income (rule of thumb)
All monthly debt payments / gross monthly income. Above this, lenders get nervous.
A 'good' mortgage at 7% on a house you can't really afford is bad debt. A 'bad' credit card balance at 0% APR for 18 months may be fine if you have a payoff plan. The label matters less than the rate, the term, and what you're buying.
Three questions before borrowing
- •What's the all-in interest rate (APR)?
- •Is the thing I'm buying going to grow in value or earn me money?
- •Can I make the payment even if my income drops 20%?
Takeaway
Ignore the label. Ask: APR, asset value, and payment safety. Three yes-answers = probably fine. Any no = think twice.
Which is generally considered 'good debt'?