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Good debt vs. bad debt

If it keeps you from your financial goals — it might be bad debt

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If you wake up each day feeling uneasy and worried about your debt, you might think you’ll never get ahead on your finances. However, not all debts are bad. Mortgages, student loans and small business loans all tend to be worth it, and even bad debt can be necessary in some situations.

Before you go into debt (or add to your existing debt), it’s important to be able to tell the difference between good and bad debt so you can decide which debts might be worth it for you.

Key insights

  • The average American credit card balance was $5,221 in 2021, according to Experian.
  • Some debts can be helpful, especially when they help you earn money in the long run.
  • Making payments on your debt helps build credit, which can strengthen your financial situation in the long run.
  • Bad debt creates frustration and stress and makes it hard to get on track financially.

Examples of good debt

“Good debt” is a fairly subjective term, but this kind of debt usually helps you achieve specific life goals. Good debt is realistically affordable to pay back over time, and it often finances purchases that earn you money later on. The following are generally considered good kinds of debt:

If a debt isn’t beyond your ability to repay and helps you earn more in the future, it’s likely a good debt.
  • Mortgages: A home loan can eliminate the need to pay rent, and homes tend to increase in value over time.
  • Home equity loans: Home equity loans and home equity lines of credit (HELOCs) can provide the money you need to make necessary home repairs or upgrades that may increase your home’s value.
  • Student loans: A student loan helps you further your education and achieve your career goals, which can lead to higher earning power or a better quality of life down the road.
  • Small business loan: A small business loan can be worth it for those with a solid business idea or product since that venture could generate a lot of income in the future.

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    Examples of bad debt

    Bad debts, on the other hand, create overwhelming financial strain and grief. Often, these debts seem impossible to repay due to unreasonable interest rates or high monthly payments. Again, the idea of bad debt is highly subjective, but it’s not uncommon to get caught in a vicious cycle with any of the following, so make sure to use caution:

    • Credit cards: Credit cards often have high interest rates, so balances can increase quickly — especially if you can’t make payments on time. They also make it easy to spend outside of your means. If you need a credit card, search for one with reasonable interest rates and be sure to pay off your balances as soon as you can.
    • Payday loans: These short-term loans require you to pay back the money with your next paycheck, often within a matter of weeks and with exorbitant interest. They tend to create oppressive cycles of debt that can leave a borrower underwater long term.
    • Car loans: Though auto loans are essential for many and often worth the cost, financing a car might not put you ahead financially unless you need it for work. Once driven off the lot, new cars typically lose 10% or more of their value in their first month, according to CARFAX data. This can put you upside down on your loan right away, which means you owe more than the car is worth. Older cars tend to depreciate slower, but a car will still generally lose value over time.
    I used to put purchases on a card to get the points or the miles, thinking about all the bonuses I’d be getting, but not thinking about the accumulated interest I’d accrue on the balances. It got out of hand.”

    Bad debts impact millions of people. “I used to put purchases on a card to get the points or the miles, thinking about all the bonuses I’d be getting, but not thinking about the accumulated interest I’d accrue on the balances,” a reviewer from New York told us. “It got out of hand, especially after my divorce and getting laid off.”

    They ended up using debt settlement services to find a way out without declaring bankruptcy or asking for help from relatives. "I learned a lot about my spending habits and how I could stay out of debt. It's made me think carefully before deciding to buy."

    How to get out of debt

    Most of the time, the best way to get out of debt is simply to pay it off. You may be able to file for bankruptcy, but this is often a last resort because it can cause significant harm to your credit history.

    Another option is to consider a debt consolidation loan. This lets you combine individual debts (from credit cards, personal loans, medical debts, etc.) into one new loan. With this option, you make just one payment each month, often at a lower interest rate.

    Being debt-free will make more of a consumer’s income available for living expenses and give them the ability to save and invest for the future.”
    — Nathan J. Brelsford, attorney

    Nathan J. Brelsford, an attorney who works with people facing financial turmoil and bankruptcy, offered us some insight on getting out of debt: "Consolidating debt can make financial sense when the consumer can lower their monthly payments and lower the interest rate and amount of interest/fees they will pay over the life of their loan(s).”

    “Being able to get out of debt and eliminate debt, especially high-interest debt, is the first step to being able to build wealth,” he continued. “Being debt-free will make more of a consumer’s income available for living expenses and give them the ability to save and invest for the future.”

    He also said not to wait to pay off debt because paying them off as quickly as possible makes the most financial sense. However, it's important to leave yourself some financial wiggle room.

    “It's also a good idea for a consumer to have a small amount saved as a ‘rainy-day’ fund to cover any unexpected expenses such as car repairs," Brelsford said. "A good amount to have saved would be a minimum of at least two months of living expenses.”


    Should I pay my credit card bills in full or leave a small balance?

    Paying off your credit card bills in full each month is a good idea — that way, you’re borrowing without interest. Having that account open and in good standing is enough to help bolster your credit score, so there’s no need to leave a small balance unpaid.

    Is a car loan good or bad debt?

    Car loans often straddle the line between good and bad debt. Buying a brand-new vehicle is exciting, but the value of the car drops as soon as you drive it off the lot because it’s no longer new. Depending on your down payment, you may owe more on it than it’s worth at this point, so it could be considered a bad debt. Even used cars generally lose value over time, so you shouldn’t expect to get more out of a car than you spend on it.

    However, an affordable, low-interest loan for a used car in good condition could be a good choice. This is especially true if you need a vehicle to get to work or school — in this case, your car is helping to benefit your financial health in the long run.

    What is a credit score?

    A credit score is a number that represents your creditworthiness. Higher credit scores let lenders know borrowers present low risk, often because they’ve demonstrated their ability to make payments on time each month and don’t have a high debt load. Credit scores often determine your eligibility for loans and lines of credit.

    Bottom line

    Debt is familiar to most Americans, and having debt isn’t the end of the world as long as you can afford to make payments on time and the interest is low. With many loans and lines of credit, however, it’s easy to get caught up in buying more than you can afford (especially with credit cards), which can lead to a cycle of overwhelming debt.

    Finding the right balance means making careful decisions when borrowing and determining which debts are most worth it for — or essential to — your quality of life and future financial well-being.

    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. To learn more about the content on our site, visit our FAQ page.
    1. Federal Reserve Bank of New York, “Center for Microeconomic Data: Data Bank.” Accessed June 10, 2022.
    2. Experian, “Average Credit Score Hits New High, While Debt Balances Rise.” Accessed June 16, 2022.
    3. USA.gov, “Dealing with Debt.” Accessed June 10, 2022.
    4. Consumer Financial Protection Bureau (CFPB), “Credit cards.” Accessed June 10, 2022.
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