We need to talk, because the good debt vs. bad debt information you see out there a lot is often completely inadequate. So, get ready for a point of view you may not have heard before.
First though, since you’re probably wondering what the difference is between good debt and bad debt, let’s go over the standard definitions of the two. Those definitions will be important for what comes next.
What do people consider good debt?
Good debt is usually defined as money you borrow in order to invest in your future or to buy an appreciating asset.
(An appreciating asset is something you buy that you believe will be worth more over time.)
So the idea is that borrowing now can help you make your life better in the future or grow your net worth.
From that point of view, student loan debts are “great” because you might be able to get a better job with a degree.
Likewise, a mortgage could be thought of as good debt because real estate may be worth more as time goes on. (And you need somewhere to live anyway.)
Also, “good debts” usually have lower interest rates compared to other kinds of things you might borrow for. (Which is not the same thing as saying the interest rates are usually low. They may or may not be.) So you might also consider it to be debt that costs you less.
What do people consider bad debt?
On the flip side, bad debt is usually defined as borrowing money:
- to buy things that are going to be worth less over time
- for things you don’t need
- at very high interest rates
This is sometimes also called consumer debt, because the money is spent on things that you use up or that will go down in value.
For example, if you take out a loan to buy a shiny new car, that car is going to be worth less the moment you drive it off the lot. And it will almost always continue to be worth less and less over time, until you have trouble even giving it away.
Credit card debt is also usually considered bad debt. For example, if you put a Nintendo or a meal out on a credit card and don’t pay it off right away, that’s bad debt because you didn’t need those things and you’re now paying a whole lot more for them.
If you take out a payday loan to make your rent payment, that’s bad debt because the interest rates are very high and it’s hard to dig yourself out of the hole. Even though paying your rent is important.
The idea is that taking on bad debt usually makes your situation worse over time or costs you a lot more.
But there are two HUGE problems with the whole good debt vs. bad debt thing.
Categorizing debts by “type” is likely meant as a shortcut for decision making, or a quick way to see how well you might be doing with your money.
But that’s exactly why it’s a problem. It’s not helpful at all.
It’s dangerous even. Here’s why.
Why labeling debt as good vs. bad is dangerous.
Let’s talk about the emotional point of view first.
At a minimum, debt is an additional financial load you have to carry. (Even if it’s at 0%.) But it’s not just about numbers or what you may do with the money you borrow.
There’s an emotional toll to pay too. Sometimes that toll is very light, if you aren’t really bothered by it and don’t lose your ability to pay it back. The money you owe is still hanging over you on some level though.
At worst, it’s a crushing emotional burden that can lead to stress, sleepless nights, or even suicide.
Real quick: If you have debt — no matter what “kind” it is, know that YOU ARE NOT A BAD PERSON. Just putting that out there, because sadly there can be a lot of emotion and shame around carrying it. Especially certain “kinds” of debt.
Debt (or lack thereof) has nothing to do with who you are as a person.
But I think everyone will agree that “good” and “bad” are loaded words. So it’s easy to feel judged by others or to judge yourself based on the things you borrow for — especially if they’re labeled with a negative word.
Which brings me to my second point about labels.
Why you shouldn’t use good debt vs. bad debt as a shortcut for decision making.
What happens when you base a decision on a little mental shortcut? You don’t stop to think.
Because you know what? “Good” sounds like a desirable thing. Like a cool glass of water on a hot day, or getting a big bonus at work. Something beneficial that we wouldn’t think twice about.
You need to think way more than twice when it comes to your money and your future.
For example, just because you’ve heard student loans called good debt do NOT mean that it’s automatically a good idea to take them out in your situation. Or in any amount. For any degree.
Sure, going to college can be a great experience, especially if it leads to a degree and a high paying job. But there’s so much to consider there! And so many what ifs. Whether or not to add loans to the experience shouldn’t be something you do without a lot of thought.
Because debt is separate from the things you use money for.
Don’t forget that, or confuse the two.
For example, I haven’t heard a lot of people say they regret going to college. Some people loved it, some people thought it was boring, and some people hated it, but only a few actually regretted it. On the other hand, I have heard many people say they regret taking out loans, or taking out such large loans instead of as little as possible.
Don’t base huge, life-altering decisions like that on a label. Not even a little. Consider as many things that could happen as you can, because life does not always go perfectly.
I’m going to harp on student loans a little bit more here, because they’ve negatively affected the lives of huge numbers of people.
To be clear, student loans are a bet. They involve risk.
It’s very much like going to Vegas and putting $50,000 in borrowed money on red. You’ve got a 47.37% chance of winning.
That chance is only slightly less than the percentage of students who graduate from college within 6 years.
The bet is great if it pays off, but not so much if it doesn’t, to say the least. Either way, you’re still betting and incurring the chance of loss when you take that bet.
Everyone would agree that putting $50,000 in borrowed money on red on a Vegas roulette wheel is very risky. But they’ll argue the benefits of taking out a student loan until they’re blue in the face while minimizing the risk. And that’s dangerous.
Even folks who do acknowledge the risk don’t really believe it’s likely to happen to them. After all, if they thought they were going to spend $20,000-$50,000 a year on college and not graduate, or borrow all that money and end up with a $15 an hour job afterward, they wouldn’t do that.
Yet that happens more often than you might imagine. And that’s not fun.
So if you’re wondering, “IS there such a thing as good debt?” the answer is no.
There’s also no such thing as bad debt. (Unless you’re talking about money someone is never going to repay you.)
So why don’t we just go ahead and call all debt what it really is instead?
That’s a heck of a lot more accurate than “good” or “bad”. Some debt is a whole lot riskier than other debt — and it’s ALL risky.
There’s the risk that you might not be able to repay it, that it will cripple your future, that you’ll miss opportunities, that you’ll be house poor, that things won’t work out the way you’d imagined, etc.
So borrowing for one reason vs. another reason may carry more or less risk, but you’re still borrowing the money, and there’s still risk involved.
Don’t ignore that risk because of a name.
You have to put thought into deciding whether or not to take on the risk in borrowing money.
Naturally, I vote no. Life is a whole lot better without debt. But maybe you are fine with it — that’s ok too, as long as you understand what could happen and are willing to accept the risk.
You have to figure out how much risk there is and how things could turn out if you borrow the money and things go wrong. (Such as by feeling stuck in a job, house, or area you dislike, or by not having money to do things you like.)
Ask what might happen if you borrow money and then:
- You lose your job and can’t find another one for more than a year?
- Your house is underwater and you need to move?
- You desperately need to sell the item later but can’t?
- You graduate from an expensive private college and end up working part time at a pet store?
- The item you buy happens to be a money pit?
- You flunk out of school, or just decide college isn’t for you?
- You forget to pay your 0% interest debt in full by the deadline?
- Your vehicle catches on fire and you’re left owing what the insurance doesn’t cover?
- You get in an accident and become disabled?
- You want to stay home with the kids or leave a horrible job, but can’t because of all those loans?
In other words, think through less-than-perfect scenarios and imagine how they might impact you, without brushing them aside mentally with an “oh but that won’t happen.” Because they could. Three of the above items happened to me.
If you’re wondering, “How much debt is OK?” that has to be up to you. Make sure you can at least eat and pay your other bills. If you’re trying to buy a house and are worried about your credit score because of that, remember that you can get a mortgage with manual underwriting. (That’s a thing you can do if you have no credit score, for example.) You can also pay cash. People DO do those things.
Note: You can check your credit scores for free using Credit Karma.
Don’t take on debt because you’ve heard you’re “supposed to” or are told it’s smart. Only do it if you want to and are ok with what life could be like if things go really wrong.
What’s smart is to have plenty of money in the bank, investments, and insurance. Those don’t require debt.
Remember that you have other choices.
Borrowing money is definitely not the only choice. It’s just the easiest-seeming and most obvious choice that sucks so many people in due to ads and the current culture.
I’ll tell you a little secret though: The debt free life is a WHOLE lot easier in the long run.
So don’t believe the good debt lie.
The idea that the debt itself is somehow good because the things you use the debt for might turn out to be positive is flawed.
Always remember that ALL debt is risky. Be sure you’re making a choice you can live with even if the thing you brush off as “never gonna happen”…does.