Good Debt And Bad Debt: How To Recognize Them - Bitter to Richer (2024)

I’m sure we’ve all heard about the debate regarding good debt and bad debt before. It can be tiresome, and it often falls into semantics. Generally, it’s safe to say you should avoid debt – however, there are ways to use it to help (more than hurt) you. In this article we’ll be going over the stereotypical uses for debt, which are bad, as well as ways debt can actually help you out. With this topic there are a lot of grey areas, but we’ll go over that too!

What Exactly Is “Good” Debt?

Usually when people talk about good debt they’re focusing on debt that you use to make yourself more money. Another use is when that debt actually saves you more in the long run. That can sound a bit weird at first, but let’s focus on the practical use cases for this. By focusing on the actual cases where debt can be used to your advantage, this concept of good and bad debt will be easier to grasp.

Education

First off, many people considering pursuing a higher education a worthwhile investment. In fact, most people go into significant debt for their college degree. Now, I can’t tell you if college is worth it for you, but if you need a degree for your profession then you may need to get student loans to pay for it. In this case, you’re using debt to catapult your earning potential. This has a solid success rate in STEM fields, however there are many degrees that don’t have a good return on your investment. When choosing a degree, just remember to be cautious!

A Business

Another good opportunity is building your own business. Sometimes, when you start a business, you have to take out a loan. If you can find a way to avoid this, that is probably for the best. However, I understand that isn’t always the case. So, if you need a loan for your business, that could be considered good debt. It’s another way to leverage debt to catapult your earning potential – and freedom. There is a certain satisfaction that comes with being your own boss after all.

Housing

Housing is a bit of a different one. We all know rent can be a lot, especially with increasing prices. In many areas of the country, it is cheaper to buy than it is to rent. This is particularly true if you plan on staying in the area for at least a few years. So, buying a house can add a lot of debt, but the interest rates are generally manageable, you can make money from it (due to the house’s increasing value), and you have a lower monthly housing expense. All-in-all, that’s not a bad use of debt either.

What Exactly Is “Bad” Debt?

Bad debt is mostly what I talk about – and how to get rid of it. It’s debt that is not advantageous at all, and is just a drain on your finances. This is what most people think of when it comes to debt, and it’s definitely something to avoid at all costs. Personally, I avoid all forms of debt that don’t offer something in turn (like an investment on a house does).

Credit Cards

One classic example is credit card debt. Consumer debt is a nasty thing, and the interest rates can be astronomical. If you find yourself in a lot of credit card debt, it can feel like it’s impossible to escape it. To be frank, it is quite difficult – even when you follow good, consistent strategies.

However, credit cards aren’t all bad. They can be a good way to ramp your credit score up in a relatively easy way. So, use them responsibly and they can be a great financial tool. If you have a hard time controlling your spending, stay far away. It’s simply not worth the risk or the massive amount of debt. After all, do you really need to go into debt for shopping (hint: you don’t)?

Cars

Another common one is cars. They’re another drain on your finances and they generally plummet in value. I have heard of people getting exceptionally low interest rates on it (under .5%), in which case it’s not so bad – at least not as bad as credit card debt. Either way, it’s certainly not a good thing to have, and as a general rule you don’t want to take on more debt than you have to. In my opinion, unless you’re a car fanatic, you are better served just buying a used vehicle.

Most Other Forms Of Debt

This is a bit of a catchall statement, but most other forms of debt fall under the “bad” category. When in doubt, just avoid taking on additional debt. If it isn’t clearly a good financial decision, then it probably doesn’t warrant the risk that comes with debt. For those who want to mitigate the risk, take the time to build up your emergency fund.

Grey Areas

Of course, as I said earlier, there are some grey areas that are not entirely bad – but they come with risk. I’ll go over them now, but know that you’ll likely need assistance to make these successful if you don’t already have extensive knowledge in the subject.

Debt Consolidation

First up is debt consolidation. There are tons of services out there that can help you with this. The main thing this can do for you is lower your interest rates and make it more manageable to pay back. Think of it this way – instead of having multiple loans out, you can work with another company that pays off all those loans and sets up a new loan with you, with a new interest rate. This is nice since it can consolidate debt from multiple sources. The best thing about it is the fact that you have the potential to lower your interest rate – in effect lowering how much you’ll have to pay to eliminate the debt.

Investing Debt

Another grey area is using leverage for your investments by going into debt. Let’s go back into the generic housing example – but let’s assume you’re a real estate investor. You may be buying investment properties using large downpayments, but you may still be using debt in order to purchase those properties. In this case you are taking on debt, and the risks, but also using it to potentially make a lot of money in the process.

Continuing with the example, let’s say you put $10,000 down on a $100,000 house (excuse the numbers, this is just to make the point clear and the math simple). If the property value increases and you sell the house a year later at $120,000, your initial investment actually increased to 300% of what it originally was! Don’t take the example too seriously, as it was just to showcase my point, but leverage does have its uses for investors.

Isn’t This All A Bit Up For Debate?

Why, yes, yes it is. The whole good and bad debate is a little over the top for me. It can be hard to classify them – especially because it depends on your situation. As a general rule of thumb, again, it’s best to avoid debt. All debt carries with it risk, just to varying degrees. If you have an opportunity where you can make or save money using debt, that is fine and is normal. The issue with leveraging debt in such a way is that you have to manage the risk that comes with it. I’m not saying that you shouldn’t do it – just be wary and research your options before you commit.

Conclusion

Hopefully this helped put an end to the good vs bad debt debate for you. If you have thoughts on the topic, let us know what they are in the comments. For more articles like this, and a free budgeting template and financial goals worksheet, be sure to sign up for the Bitter to Richer newsletter.