Bad Debt vs. Good Debt

Debt is a complicated topic in the financial world. Conventional wisdom would say to avoid debt at all costs.

As we discussed in our Buy Now Pay Later article, if you can’t buy it in cash, you shouldn’t buy it at all.

While this wisdom holds for typical Buy Now Pay Later purchases like takeout, there are certain kinds of purchases that may be worth going into debt over. 

Keep reading to find out some examples of good debt. We will however, start with the bad.

Bad Debt

Some things are just not worth going to debt over. The easiest way to determine if something is bad debt is to look at what the debt is for. Are you buying something that will quickly lose value? Or is it something that you can only use once? If it's either of those things, it's likely never going to be worth taking out a loan for it. Here are some common examples:

• Expensive Vehicles: Taking out a loan to buy an overpriced, depreciating asset is almost never a good idea.

• Credit Card Debt: Credit cards carry insanely high interest rates. For everyday purchases, it is best to pay in cash or to always pay your credit card bill in-full every month. 

• Consumable Purchases: Going into debt for ordering expensive takeout, buying trendy clothes, or financing a vacation you can't afford is a common trap. Once the food is eaten or the vacation is over, the experience is gone, but the monthly bill remains.

Good Debt

Good debt can often be summarized as debt that will actually increase your wealth in the long-run, or is absolutely necessary. A few examples are:

• Student loans: Taking out loans for a degree that will vastly increase your earning potential.

• Mortgages: Getting a mortgage to build equity in a home that will appreciate over time. Many people’s most valuable asset is the home they have spent 30 years paying off.

• Transportation: If your job requires you to commute to work and you cannot afford a car in cash, it is likely in your best interest to get a loan to buy a car so that you can earn money at your job. 

As we saw before, a car loan could also be bad debt, especially if you buy a car that is outside of your budget or a model with poor reliability.

The other aspect of good debt is debt that is out of absolute necessity. Going into debt to buy essentials such as food, water, and a roof over your head is always better than not buying them at all. 

The Bottom Line

The line between good and bad debt is quite thin. The same student loans that you took out to increase your earnings potential will not guarantee a high-paying job. The same house you bought could have many hidden problems and become a money pit. 

That may be bleak, but the moral is that going into debt will always carry some risk, but that risk can be worth it for some individuals.

Very few people can afford medical school without loans, but those who make it through are able to re-pay their loans and often live very successful, wealthy lives.