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Good Debt vs Bad Debt: What’s The Difference

03 Jul 2023

Debt is something that just about everyone experiences in their lifetime. It can be in the form of loans, credit cards, mortgages, or other financial obligations. But did you know that there is such thing as good debt and bad debt?

Good debt and bad debt are terms used to describe different types of borrowing based on their potential benefits and risks. So, what exactly is good debt, and what is bad debt?

Good Debt:

Good debt refers to borrowing that can potentially bring long-term benefits or improve your financial situation. It typically involves investing in assets that have the potential to increase in value or generate income. Examples of good debt include:

  • Mortgage: Taking out a mortgage to purchase a home can be considered good debt. Real estate generally appreciates over time and owning a home can provide stability and potential equity growth.
  • Student Loans: Borrowing money to invest in education or professional training can be seen as good debt. It can enhance your skills, increase your earning potential, and lead to better job opportunities.
  • Small Business Loan: Starting or expanding a business often requires borrowing money. If the business is well-planned and has potential for profitability, taking on a loan can be considered good debt.
  • Investment Loans: Borrowing money to invest in stocks, real estate, or other income-generating assets can be considered good debt if the potential return outweighs the cost of borrowing.

The key characteristic of good debt is that it has the potential to increase your net worth over time or improve your financial situation over time.

Bad Debt:

Bad debt refers to borrowing money that typically does not provide long-term benefits and can negatively impact your financial well-being. It often involves purchasing items that quickly lose value or using credit for unnecessary expenses. Examples of bad debt include:

  • Credit Card Debt: Using credit cards to make impulsive purchases without the ability to pay off the balance in full can lead to high-interest debt. Paying excessive interest charges can be detrimental to your financial health.
  • High-Interest Consumer Loans: Borrowing money at high interest rates for non-essential purchases, such as luxury items, can be considered bad debt. These loans often come with high costs and may take a long time to repay.
  • Car Loans: While having a car may be necessary for some, taking on excessive debt to purchase a brand-new vehicle can be considered bad debt. Cars typically depreciate, and high-interest loans can lead to negative equity.
  • Payday Loans: These short-term, high-interest loans are often used by individuals facing immediate financial challenges. However, due to their exorbitant interest rates, they can quickly trap borrowers in a cycle of debt.

The key characteristic of bad debt is that it does not contribute to long-term financial growth and can lead to financial stress and difficulties in repaying the debt.

It's important to note and know that the classification of debt as "good" or "bad" can vary depending on individual circumstances and financial goals. While some types of debt are generally considered more favourable, it's crucial to carefully evaluate the risks, costs, and potential benefits before taking on any debt.