Good Debt vs. Bad Debt: Differences and ExamplesJuly 7, 2021
As a nation, we run on debt. Student loans, auto loans, personal loans, credit cards and mortgages — many people have all of those forms of debt and more. In fact, Experian reported that consumers have an average outstanding balance of $92,727.
But not all debt is equal. Some forms of loans or credit are considered “good debt”. But what exactly does that mean? Here’s what you need to know about good debt vs. bad debt.
What is good debt?
Unfortunately, the cost of living, getting an education, and caring for your health are expensive. Few people can afford to pay for all of their expenses out of their savings or with their monthly cash flow, so using debt to cover the cost is extremely common. You can use debt to buy a home or a car, and debt can even help you earn a college degree.
“Good debt” is an unofficial term some people use to label certain forms of debt. It refers to money you borrow to increase your income or improve your future earning potential. By contrast, bad debt doesn’t have any return, and can actually hurt your finances.
Examples of good debt
The following examples are common forms of good debt:
In the United States, the average sales price for houses was $403,000 in 2021. If you don’t have that much money tucked away in savings or investments — and very few people do — you’ll have to borrow money through a mortgage, also known as a home loan.
Mortgages are generally considered good debt because houses typically appreciate in value. According to Zillow, the average annual appreciation rate is between 3% and 5%. If you live in your home for a few years, your home will be worth more than you owe, and you could sell it for a profit.
Mortgages are a tool you can use to purchase a home and build equity, bettering your net worth.
2. Student loans
With rising college costs, the majority of students have to borrow money to pay for their educations. However, student loans are another common form of good debt because having a degree can increase your employability and earning potential.
The National Center for Education Statistics reported the median earnings for college graduates between the ages of 25 and 34 were 57% higher than the median earnings of individuals with only a high school diploma. For those who got a master’s degree, their median earnings were 19% higher than bachelor’s degree holders. And, those with a bachelor’s degree or higher tend to have lower rates of unemployment.
|Degree Type||Earnings||Unemployment Rate|
|Some high school completed||$27,000||9%|
|High school diploma||$34,900||9%|
3. Business loans
If you have a great idea for a business, but need money to get it started, a loan that covers your initial costs can be good debt. If your business is based on sound principles and has a large customer base, you can quickly repay the loan and grow your business’ profits.
Examples of bad debt
Bad debt is money you borrow for depreciating assets, or assets that have no benefit to your net worth. For example:
1. Auto loans
Cars can be prohibitively expensive. If you need to buy a new vehicle, you may need to take out an auto loan to complete the deal.
However, use auto loans carefully. That means borrow the absolute minimum and choose the shortest possible loan term. Cars depreciate in value very quickly, so you’ll never be able to recoup what you borrowed.
2. Credit cards
Credit cards tend to have very high interest rates. If you use a card for unnecessary purchases, like travel clothing, or meals at restaurants, you can end up paying far more than you initially charged due to interest charges.
3. Personal loans
Personal loans can be used for a wide range of purposes, such as booking a dream vacation, renovating your home, or paying for medical expenses. Because personal loans are typically used for one-time expenses or items without lasting value, they’re a type of bad debt.
Do student loans always count as “good debt”?
While a type of debt may be considered “good,” that doesn’t mean you should always use them. Even forms of good debt, such as student loans, can harm your finances if you aren’t careful.
When deciding whether taking out a student loan is worth it, consider the following:
Are student loans a good idea? It depends on the loan’s purpose. If you’re taking out money for necessary school expenses, such as your tuition, lab fees, or textbooks, then student loans can be a smart choice. But if you’re using your loans for unnecessary expenses, like ordering pizza, a spring break trip, or the latest smartphone, they can quickly become bad debt.
Here’s a useful guideline to follow: the maximum amount of money you should borrow in student loans should not exceed how much you expect to earn in your first year of working after graduation.
For example, let’s say you’re planning on becoming a teacher. According to ZipRecruiter, the national average salary for entry-level teaching positions is $35,909. If you need to apply for student loans to pay for college, you should borrow no more than that number to ensure you can afford your payments.
Are student loans good or bad? There’s no one right answer, but doing good research and working with a reputable lender can make a big difference in ensuring a stronger return on your investment.
Before submitting a loan application, do your homework and compare your options. Federal loans tend to be an excellent place to start, but if you need to borrow more money, private student loans can be a good way to cover your remaining costs.
With ELFI, you can get a quote for a private student loan by filling out a simple form.* Getting a quote won’t affect your credit score, and if approved, you can adjust your loan repayment term to meet your needs.