Good debt is debt that you take on to achieve meaningful growth in your personal life or finances, like a mortgage or student loan. Bad debt is relatively expensive debt and debt that someone takes on for unnecessary expenses, like credit card debt.
Some people consider any debt to be bad. Others take a more nuanced approach. You might categorize debt as either good or bad depending on how youre using the money you borrow, the terms you receive and how the debt could benefit you.
Heres what to know about good debt versus bad debt and why understanding the differences between the two could help your long-term financial health.
Debt often gets a bad reputation, but not all debt is created equal. While high-interest credit card debt can drag you down financially certain types of “good” debt can actually help you build wealth over time. This article will explain what healthy debt is provide examples, and give tips on how to use it strategically.
What is Healthy Debt?
Healthy debt is debt taken on to purchase assets that have the potential to increase in value or generate income over time. The key characteristics of healthy debt are
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Low Interest Rate: Ideally less than 6%, which results in more of your payments going toward the principal rather than interest.
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Investment Potential: The debt is used to purchase assets that may appreciate in value like real estate or education.
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Income Generation: The asset purchased with the debt produces income that can help pay off the debt.
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Manageable Payments: The payments fit comfortably within your budget.
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Clear Payoff Timeline: You have a plan to pay off the debt within a reasonable timeframe.
Healthy debt aligns with your long-term financial goals and puts your money to work for you. When used strategically, it can increase your net worth and provide leverage to acquire assets that may otherwise be out of reach.
Examples of Healthy Debt
Here are some common examples of debt typically considered “good” debt:
Mortgages
Mortgages allow you to purchase real estate that has potential to increase in value over time. As you pay down your mortgage, you build equity in the property. Mortgages tend to have lower interest rates, helping you pay off the debt faster.
Student Loans
Student loans enable you to pursue higher education, which can significantly boost your earning potential. Focus on degrees with strong career prospects that justify the cost. Prioritize federal loans over private loans whenever possible.
Business Loans
Borrowing to start or expand a business can generate significant income over time to pay off the debt. Just be sure to realistically project future cash flows and profit potential before taking on the debt.
Investment Property Loans
Like your primary residence, investment properties can appreciate in value and produce rental income. A 20-25% down payment is recommended to lower your risk as an investor.
Home Improvement Loans
Strategic renovations like kitchen and bath updates can increase your home’s value. A home equity loan or line of credit taps your equity at low rates.
Signs of Unhealthy Debt
On the flip side, here are indications that debt may be “bad” rather than “good”:
- High interest rate, usually above 6%
- Borrowed for depreciating assets like cars or vacations
- Minimum monthly payments only cover interest
- No potential to build income or equity
- Payments stretch your budget
- No plan to pay off the debt
This type of debt drains your cash flow without providing long-term financial benefits.
Tips for Managing Healthy Debt
If you use debt strategically, it can be a tool to build wealth. Here are tips for keeping your debt healthy:
- Comparison shop for the lowest rates when borrowing
- Make payments on time to protect your credit score
- Pay extra toward principal to pay loans off early
- Review terms before renewing/refinancing debt
- Monitor property values on assets acquired with debt
- Have a payoff plan and timeline for all debt
The key is using leverage wisely to acquire assets aligned with your financial goals, not simply taking on debt for short-term wants. When used properly, healthy debt can unlock opportunities and provide an earnings engine to create lasting wealth.
What Is Bad Debt?
You might classify debt as bad debt based on how the borrower uses the money, the debts terms or whether the debt will yield long-term benefits.
For example, if you take out a loan for discretionary purchases, such as a vacation or shopping, you could end up paying significant interest charges over time. That might be considered a poor use of debt. A debt that has a high interest rate or fees could also be considered bad debt, even if you use the debt for an essential purchase.
One way to compare loans is to calculate the annual percentage rate (APR) of the various options to see which one will cost more on an annualized basis. A loans APR considers the interest rate, certain fees and repayment term.
What Is Good Debt?
Good debt tends to be debt that allows someone to achieve meaningful personal goals or could lead to long-term financial gain.
For example, someone who wants to become an attorney will likely need to borrow a lot of money for law school. They might graduate with over $100,000 in debt, but the loans allow them to achieve their dream and potentially set them on a path toward a lucrative career.
Is There Such a Thing as Good Debt?
FAQ
What is considered healthy debt?
Good debt is money you borrow for something that has the potential to increase in value or expand your potential income. For example, a mortgage may help you buy a home that can appreciate in value. Student loans may increase your future income by helping you get the job you’ve wanted.
What is health debt?
Medical debt is a debt that arises from a visit or interaction with a health care provider, such as a hospital, clinic, doctor, or nurse. Two-thirds of medical debts are the result of a one-time or short-term medical expense arising from an acute medical need.
What can be considered good debt?
Quick Answer. Good debt is debt that you take on to achieve meaningful growth in your personal life or finances, like a mortgage or student loan. Bad debt is relatively expensive debt and debt that someone takes on for unnecessary expenses, like credit card debt.
Is $6,000 in credit card debt a lot?
The average American household has over $6,000 in credit card debt, which can be a challenging amount to manage. If you’re just making minimum payments, expect to stay in credit card debt for many years – about 25 years on $6,000, by our calculations.