What’s the difference between good debt and bad debt?

Credit & debt, Credit cards, Money

Experts don’t always agree. Some financial experts argue that there is no such thing as good debt. But others recognize that debt can be a valuable financial tool when used wisely.

How do you tell good debt from bad debt? Which types of debt can benefit you, and which types should you avoid?

Here’s what we cover:

  • The different types of debt
  • What is good debt?
  • What is bad debt?
  • Oportun: Affordable personal loans to improve your financial future

Key takeaways

  • Debt can either be good or bad, depending on how you use it. The difference between good debt and bad debt is how it affects your finances in the long run.
  • Good debt is any type of debt you use to improve your finances in the long run. Some examples of good debt are student loans, business loans, and mortgages. These types of debt allow you to invest in your financial future. For debt to be considered good, it also must be affordable.
  • Bad debt is any debt that puts you in a worse financial position in the long run. Revolving credit card debt and payday loans are two examples of bad debt. If you can’t pay back your debt on time, it’s bad for you.

The different types of debt

Some common types of debt include:

Each of these types of debt may come in handy when you need to borrow money. But only some of them are considered good debt in the long term.

What is good debt?

You may have heard the phrase it takes money to make money. Sometimes you need to borrow money to invest in your future. Good debt helps you do just that.

Good debt is any type of debt that helps you improve your financial position in the long run. Good debt allows you to invest in yourself. You might use good debt to buy a car or a home, pay for a college education, or grow a successful business.

The most important thing about good debt is that it’s affordable, with budget-friendly payments. Too much of any type of debt can turn bad if you can’t make the payments on time.

Here are some examples of good debt.

1. Student loans

Student loans help you pay for education-related expenses. These loans allow you to attend trade school, college, or graduate school even if you can’t afford the tuition right away.

Having more education has been shown to increase your earning potential. By taking out a student loan, you can get the education you need to expand your career opportunities and pursue a high-paying job.

Because student loans may help you increase your wealth in the long run, they’re considered good debt.

2. Business loans

Business loans are another type of good debt. Taking out a business loan can provide you with the money you need to:

  • Start a new business
  • Buy business equipment
  • Invest in business-related property
  • Pay for day-to-day business expenses

If you use your business loan wisely, you may be able to increase your profits for years to come.

3. Mortgages

A mortgage is a great tool to help you buy a home. Taking out a mortgage means agreeing to a long-term debt, but for many people the satisfaction of owning a home is more than worth the commitment.

If you currently rent your home, you have to make rent payments each month. You’ll never get that money back. When you become a homeowner, your mortgage payments go toward owning your home fully. If you decide to sell your home in the future, you could earn a profit from the sale.

What is bad debt?

Bad debt is any debt that harms your finances in the long run. Bad debt is typically used to buy things that don’t increase in value over time.

We all need food and clothing, for example, but you wouldn’t want to borrow money to pay for these necessities of daily life. If you go into debt to buy these items, you’ll have to pay interest on the money you borrowed. And the longer you take to pay it back, the more interest continues to build up. This can make it incredibly difficult to pay off debt and  could easily put you in a worse financial situation than you were in before.

Here are a few examples of bad debt.

1. Revolving credit card debt

Credit card debt can either be good or bad, depending on how you handle your account.

Many credit card companies offer rewards like frequent flier miles, cash back, and other benefits. As long as you pay off your entire credit card balance each month, you can enjoy these benefits without owing interest. Used in this way, credit cards can be valuable financial tools.

However, many people find it difficult to pay off their credit card balances every month. One report found that two out of every three credit cards carry a revolving (unpaid) balance from month to month.

If you don’t pay off your credit card balance in full, you will owe additional interest on it each month. And the longer you wait to pay off your balance, the more money you’ll pay in interest. When your credit card balance is no longer affordable, it’s bad debt.

Keep in mind that there are many credit cards on the market, and they’re not all the same. Some cards are more affordable and offer better rates than others. Before you take out a credit card, it’s a smart idea to look closely at the interest rates, fees, and conditions. Be sure you understand what it will cost you to use the card if you don’t pay off your balance each month.

2. Payday loans

Payday loans are one of the worst types of debt because they are difficult to pay back on time and can harm your finances.

Payday loans can be tempting for several reasons. You can use them to pay for just about anything. Plus it’s usually quick and easy to get a payday loan because the lenders rarely check your credit score.

But payday loans must be repaid in full in a short time, typically in two to four weeks. That quick turnaround makes them difficult to pay back.

Besides that, the interest and fees on payday loans are extremely high. Even if you can pay back your loan on time, you may owe 400 percent or more in interest. If you can’t pay it back on time, you may have to renew the loan and pay a new set of fees plus more interest.

For all these reasons, it’s better to avoid payday loans. Fortunately, there’s a good alternative: personal loans.

Personal loans

Personal loans can also be used to pay for a variety of personal expenses, and they usually charge far less interest than payday loans. This makes them much more affordable.

Personal loans also come with longer terms, so you have more time to pay them back. As a result, you won’t get stuck in a dangerous cycle of having to renew your payday loan and owing high fees each time.

And the best part? An affordable personal loan can help you establish and build the credit history you need to access more affordable credit products in the future.

Oportun: Affordable personal loans to improve your financial future

As you can see, debt can be either good or bad. By taking advantage of good debt and avoiding bad debt, you may be able to improve your financial future. The most important thing is to choose debt that you can afford to pay back on time.

If you’re looking for an affordable personal loan, Oportun can help. Personal loans can be used to pay for a variety of personal expenses, and they charge far less interest than payday loans. Our loans come with budget-friendly payments, low interest rates, and personalized payment schedules so you can pay them back over time. We’ll work with you one-on-one to find a loan that fits your budget. Best of all, you don’t need any credit history to apply.

Find out if you prequalify for one of our personal loans today.

 

Sources

Association of Public and Land-Grant Universities. How does a college degree improve graduates’ employment and earnings potential?

Consumer Financial Protection Bureau. New report explores the extent of revolving in the U.S. credit card market

Consumer Financial Protection Bureau. What is a payday loan?

Consumer Financial Protection Bureau. CFPB finds four out of five payday loans are rolled over or renewed

 

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