Good Debt vs Bad Debt: How to Tell the Difference

You've probably heard 'all debt is bad.' That's too simple. Some debt helps you build wealth — it increases your earning power or acquires appreciating assets. Other debt destroys wealth — it finances consumption at high interest rates. The difference matters.

What Makes Debt 'Good'?

Good debt has at least one of these characteristics: low interest rate, finances an asset that appreciates or increases earnings, and the return on the borrowed money exceeds the interest rate. Good debt is a tool — used strategically, it accelerates wealth building.

Examples of Good Debt

• Mortgage — real estate typically appreciates; you need housing anyway; mortgage interest may be deductible
• Student loans (carefully) — a degree that increases your income by $20,000/year is worth $60,000 in loans, not $200,000
• Business loans — borrowing to invest in a business that generates returns above the interest rate
• Investment property loans — when the rental income exceeds carrying costs

What Makes Debt 'Bad'?

Bad debt finances consumption (things that don't increase in value), carries high interest rates, or both. You're paying extra for something that provides no financial return. The item depreciates while the interest accumulates.

Examples of Bad Debt

• Credit card balances at 20%+ APR — the interest alone is wealth destruction
• Payday loans — often 400%+ APR, designed to trap borrowers
• Auto loans on luxury vehicles — cars depreciate 20% in year one
• Buy Now Pay Later for consumer goods — can fragment spending and lead to overcommitment
• Personal loans for vacations or weddings — financing experiences at 10%+ interest

The Gray Area

Car loans can be good or bad depending on the rate and necessity. A 3% auto loan on a reliable vehicle to get to work: borderline acceptable. A 9% loan on a new luxury SUV: bad debt. Student loans for a low-earning degree at a high-cost school: often bad debt despite popular perception.