Good debt vs bad debt: how can you tell the difference?

By Athena Valentine Lent

Reviewed by James Heflin

Feb 25, 2024

Read time: 8 min

A happy couple sitting on the cozy sofa at home and going over their finances

Key takeaways:

  • To determine if a debt is good or bad, check your interest rate, ask yourself what it’s for, and assess your plan to pay it back. 

  • Debt is a tool that, in the right circumstances, could help your financial situation. 

  • If you have unwanted debt—good or bad—you have options to get rid of it.

Words are powerful, especially when it comes to talking about your finances. All debt is not created equal, and there’s probably no debt that’s always good or always bad. So, get curious about your debt. Figure out whether it’s working for you and your unique situation. If it isn’t, look for ways to get rid of it.

What is good debt, and what is bad debt?

Debt is often called “good” or “bad.” But what does that mean? Is a mortgage always good? Is a credit card always bad? 

Here are some basic guidelines.

Good debt is a tool that helps you reach your financial goals. For example, for most people it makes sense to take on debt for a home. Good debt can also help you get through an emergency that you can’t cover with the cash you have on hand. 

For a debt to be good, the cost must be fair. The price you pay should align with what’s available to most people at the time you borrow. 

A debt might be bad if it outlives the value of the thing you borrowed for. You might also consider a debt bad if it’s so expensive it’s hard to make any progress paying it down. Payday loans are in the bad category because their cost is so high as to be considered abusive. Credit card debt is often considered bad because the rates are high and the payment structure is designed to maximize the interest you pay.

Factors to consider in evaluating debt

Sometimes whether a debt is good or bad for you isn’t obvious. A debt that makes perfect sense for one person might be a bad move for someone else. Ask yourself these questions to determine whether a debt is good or a financial mistake. 

Why do you want to borrow?

Clarify why you are borrowing in the first place. Are you taking on this debt to improve your life? Is it because you want something that you can’t afford? Is it because you don’t want to wait? Is it something most people borrow for? Would you be able to reach the goal without going into debt?

What are the terms?

The terms you agree to will affect your budget and the overall cost of the debt. When you’re considering a debt, look at these details: 

  • The repayment period. Your repayment period is how long you’ll have to repay your original loan. A longer repayment period could get you a lower monthly payment, but it makes the debt stick around. A shorter repayment period means you’ll pay less interest overall and get rid of the debt faster, but you’ll make bigger monthly payments. 

  • The interest rate. Interest is the cost of borrowing money. Some interest rates are variable (they can change). Some interest rates are fixed (they don’t change for the life of the loan). Interest rates vary by lender. The rate you qualify for often depends on your credit standing. 

  • Fees. Loan fees are what the lender charges for making the loan. Most loans come with fees. It’ll be up to you to decide whether the fees are fair and whether they increase the cost of the debt beyond the value you’ll get. You should also research whether there’s anything you could do to lower the fees you’ll pay. The lender can help answer some of these questions. 

  • The APR. The annual percentage rate (APR) is a number that considers both the interest rate and the fees. On loans, the APR is usually higher than the interest rate. On credit cards, it’s usually the same as the interest rate because there are no loan fees. When you compare loans that have fees, be sure to compare APRs. A loan with a lower interest rate could cost you more than a loan with a higher interest rate if the fees make a big enough difference in the APR.

Talk to your lender about what factors affect the terms. Sometimes, you can lower the cost of your debt by improving your credit profile, borrowing less, or taking a shorter repayment period. 

What will you end up with in the end?

The most important question when deciding whether a debt is a solid financial decision is: what’s the result of taking on this debt? 

  • Are you gaining something of value, such as a car or a home? 

  • Is the thing you’re getting worth at least as much as the amount you have to borrow? 

  • Are you taking care of medical bills or an emergency? 

  • How long will it take to repay the debt? 

  • Will you regret taking on this debt if you’re still paying it off years from now? 

  • If you’re comfortable with your reasons for borrowing, have you researched other ways to finance the expense so that you can be sure you’re choosing the loan that best meets your needs?

Strategies for managing debt

Once you’ve decided which kind of debt you have, consider your next steps. No matter what kind it is, you can manage the debt. Here are a few strategies to help with debts, good or bad.

Set financial goals

Have a date in mind when you want to be free of your debt. 

Check your budget

Make a budget if you don’t have one yet. Your budget is simply you telling your money where to go. If you don’t know how to budget yet, it’s not hard to learn. Review your expenses (how much you spend on bills) and your income (the money you have coming in). Look for areas where you can spend less, leaving you more money leftover for debt repayment. 

Handle the debt like a pro

The number one way to pay off your debt strategically is to make sure your payments are on time every time. You’ll avoid late fees, build a strong credit profile, and make steady progress toward payoff. You can set reminders in your calendar to do it manually or set up automatic payments, so it’s one less thing to worry about. If you’ve done your budget and found some extra bucks, use the surplus to pay down your balance. If you pay off your loan early, you could save on interest charges. 

Create a debt repayment plan

Paying off debt is more manageable if you have a plan. Two of the most popular debt repayment plans are the debt snowball and the debt avalanche. You can also use an easy debt paydown app to help you make a debt payoff plan.

In both methods, you’ll make the minimum payments on all of your debts except one priority debt. That debt gets all the extra money you can throw at it. In the snowball method, your priority debt is the one with the smallest balance. In the avalanche method, your priority debt is the one that has the highest APR. Once the first debt is paid off, you give all that extra juju to the next one on the list.  

Prioritize high-interest debt

The higher the interest rate on a loan or credit card, the more you pay back. If you have more to pay back, it’ll probably take longer to get rid of the debt. 

Set your sights on your most costly debts. If you have any short-term loans (like payday loans), get rid of those first. Then focus on high-interest credit card debt. 

Explore debt consolidation options

Debt consolidation means using a new loan to pay off more than one debt. It could make sense to use this strategy when you can get an interest rate on the new loan that’s lower than the rate on the debt you’re consolidating. A big benefit is that a consolidation loan usually reduces the number of monthly payments you have to make, which also means fewer due dates to track. Also, your loan payment could be lower than the total of all the minimum payments on the debts you consolidate. Debt consolidation could help you streamline your finances and focus on knocking down your balance. 

Leave debt behind, so you can move forward

Get rid of your debt and free up your cash flow without a loan or great credit.

Seek professional help if the debt is more than you can handle

If you’re overwhelmed by your debt, it might be time to speak with a debt expert. This is someone who can listen to the details of your situation and explain your options. If you can’t afford to fully repay your debts, you might qualify for debt resolution. Resolving debts means getting your creditors to agree to accept less than the full amount you owe, and forgive the rest. Sometimes creditors are willing to do this if you can show that you’re experiencing financial difficulties.

Avoid the shame game

Don’t knock yourself if you have bad debt. Give yourself a break. If you feel embarrassment or shame over your debt, try to let that go. Focus on the actions you’re taking to get past the debt, including learning about different strategies to get rid of your debt and avoid bad debt in the future.

What’s next

  • If you have debt, list each account, the reason for the debt, the interest rate, and the minimum payment. This information will help you decide how to get rid of your debts and which one to start with.

  • If you’re considering a debt and you’re not sure if it’s good or bad, first write down the details (the reason for the debt, the interest rate and fees, the expected payment amount, and the expected repayment term). Search online to get a sense for what’s available. Keep in mind that when you see rates advertised, those are for people with the highest credit scores, and other people pay more.

  • Get in touch with a loan consultant if you need an expert to help you understand your options.

Athena Valentine Lent

Athena is one of Achieve’s content writers. She’s an award-winning advice columnist for Slate Magazine and author behind “Budgeting For Dummies” (Wiley 2023). Her writing has appeared in BuzzFeed, Tripadvisor, The College Investor, GOBankingRates, KeeperTax, and her personal website, Money Smart Latina.

James Heflin - Author

James is a financial editor for Achieve. He has been an editor for The Ascent (The Motley Fool) and was the arts editor at The Valley Advocate newspaper in Western Massachusetts for many years. He holds an MFA from the University of Massachusetts Amherst and an MA from Hollins University. His book Krakatoa Picnic came out in 2017.

Frequently asked questions

If the loan is helping you improve your quality of life, credit, and/or taking care of an emergency, a personal loan could be a good debt. If the loan is for a luxury or for something you can’t afford, or if the end result isn’t worth the amount you’ll eventually repay, it might not be a good debt. 

“Good” is not the same as “affordable.” A debt might turn from good to bad for you if it stretches your budget too thin or to the point of breaking. And an affordable debt might not be a good debt if the terms are abusive or it wasn’t a good idea to take on the loan in the first place.

If a loan’s interest rate is triple-digits, it’s a bad debt. Payday loans and title loans generally fall into this category. Also, if the thing you’re borrowing for isn’t worth the amount you’ll eventually repay, it might be a bad debt for you even if it might be okay for someone else.

Credit card debt is often considered bad debt because the interest rates tend to be high compared to other kinds of financing. Also, credit card minimum payments are designed to keep you in debt for a long time and maximize the amount of interest you eventually have to pay.

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Get rid of your debt and free up your cash flow without a loan or great credit.

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