Good Debt vs Bad Debt

The word debt often carries a stigma, but having debt isn’t a reflection of your character or how smart you are with money. Not all debt is the same. Terms like “good debt” and “bad debt” are often used to help explain the differences between types of borrowing. Some debts, like student loans or mortgages, can help you achieve long-term goals. Others, like high-interest credit card balances, can be riskier and harder to manage. Calling something “bad debt” isn’t about placing blame — it’s just a signal that it may be time to take a closer look and create a plan to get back on track.

Almost everyone takes on debt at some point; it’s a normal part of managing finances. At the beginning of 2024, American households owed creditors a combined $17.987 trillion, including student loans, credit cards, mortgages, medical bills and more.¹

Debt can be a valuable tool that makes it possible to achieve your financial goals, but it can also be a stumbling block on your way. The difference comes down to a few factors, including the terms and conditions of each loan or credit card. These terms include the interest rate and repayment plan — the amount and purpose of the debt, and how long it will take to pay it off.

Understanding the characteristics of good versus bad debt could help you make smart borrowing decisions that keep you on track to reach your goals.

Good vs bad debt – what’s the difference?

Sometimes, you may need to borrow money to reach important milestones, like buying a home or going to college. When a loan allows you to acquire an asset or helps you build long-term wealth, it’s usually considered good debt. If you borrow $50,000 to attend college, for example, your degree may eventually help you double or even triple your earning potential over your lifetime, making the debt worthwhile.²

Bad debt, on the other hand, can put your financial future at risk. This kind of debt often comes with high interest rates and doesn’t offer lasting value. Borrowing money for things you don’t truly need, like putting a new smartphone on a credit card when your current one still works, can be considered bad debt. The item may lose value quickly, and you’ll end up paying far more than it’s worth once interest is added.

Any type of loan or credit may become bad debt if it starts hurting your ability to stay on top of your bills and buy the things you need. Taking on more debt than you can reasonably afford is never a good idea, no matter what type of debt it is. Before you apply for any kind of loan or line of credit, make sure you have a repayment plan and consider your debt-to-income ratio (DTI). Your DTI is the percentage of your monthly income that goes toward paying your bills and debt. Lenders typically prefer a DTI below 36%.³ You may want to reconsider taking on more debt if new monthly payments push your DTI over that number.

Common forms of good debt

You might determine whether a debt qualifies as good by seeing how it fits into your financial plans. Consider your goals — do you hope to buy a house, retire, pay off debts or simply achieve financial stability? Good debt acts like a steppingstone to those goals.

The following types of debt are often considered good. Remember, though, that any kind of loan could cause financial problems if not managed responsibly.

Mortgages

A mortgage is a loan you use to buy a home. Taking out a mortgage is a major financial decision with a lasting impact on your finances. Most mortgages are repaid in equal monthly installments over many years. Most borrowers choose 15-, 20- or 30-year terms, though other term lengths are available.⁴ The average mortgage debt in the U.S. for a single-family home in 2024 was $263,923, making mortgages the biggest loans many people take out in their lifetimes.⁵

Of course, owning a house is valuable for many reasons — you can raise your family there, decorate or remodel how you want, and enjoy the comforts of living in your own space. Buying a home can have monetary benefits, too. Property typically gains value over time. For example, if someone purchases a home with a $264,000 mortgage and decades later sells the home for twice as much, the return on that mortgage makes it a good debt.

That doesn’t mean a mortgage can never go wrong. Falling behind on payments could have disastrous consequences for your credit score or even cause you to lose your home. You shouldn’t take out a mortgage without a solid repayment plan. If you take out a mortgage and then struggle to cover payments, you should reach out to your lender to come up with a plan for getting back on track.

Student loans

A college degree could unlock a new chapter in your life and set you up for a successful career. According to a 2021 report, people with bachelor’s degrees make 75% more than those with a high school diploma.⁶ Student loans are often considered investments in the future.

However, many factors could affect the return you receive from a student loan. While recent graduates in certain fields could land high-paying jobs quickly, others may take years or decades to earn enough money to offset their debts. In the meantime, monthly payments could become difficult to manage. While federal student loans typically have low interest rates, private student loans can come with higher interest rates, which may lead to a more expensive repayment amount.

Car loans

Unlike a home or a college degree, a car typically loses value over time. However, for many people, a car is a necessity. Unless you live in a city with available and reliable public transit, you likely need a car to go to work and run errands. A car loan is considered good debt, because it enables you to earn income and move toward your goals.

Since cars tend not to get more valuable over time, it’s important to be mindful of how much you spend financing and maintaining your vehicle. To help keep costs manageable, experts suggest that your total monthly expenses for maintaining your car — including your loan payment, gas and insurance — shouldn’t exceed 20% of your take-home pay.⁷

Common forms of bad debt

Bad debt doesn’t come with clear long-term benefits. It may even slow you down with high interest rates and tough terms. Bad debt typically grows quickly and could easily become unmanageable, leading to financial stress. While you don’t necessarily have to avoid all types of bad debt all the time, you should only have it if you have an absolute plan for repayment.

High-interest credit cards

Using credit cards doesn’t have to be considered bad. In fact, the right credit card could help you build your credit history, manage cash flow issues and earn rewards, like cashback or travel miles. However, falling behind on credit card payments could lead to bad debt, especially if your card carries a high interest rate. Your interest rate typically depends on your credit history and what level of risk the lender has assigned to you. If your history shows a lot of missed payments, credit card issuers may give you a higher interest rate. Always read the terms and conditions before you open a credit card account.

If you repay your credit card balance in full each month, you typically don’t have to worry about interest rates. But if you carry a balance, the unpaid balance accrues interest every day. Credit card interest compounds, meaning it builds on itself. As a result, credit card debt grows quickly, especially if your interest rate is higher than 20%.

To manage credit card debt, try to repay your entire balance in full whenever you can. Paying only the minimum amount required every month will increase your debt. Avoid using your card for purchases and especially cash advances you can’t afford. If you already have credit card debt, try to pay more than the minimum required amount each month.

Title loans

Auto title loans, like payday loans, often have short repayment terms. A title loan doesn’t require a credit check or even proof of employment, making it a tempting option for people in difficult financial situations. All you typically need to qualify for a title loan is your own car. To receive cash, you hand your car title over to the lender as “collateral,” which means it’s an item of value you’re using to secure the loan. A title loan doesn’t usually get you much money — typically just 25% to 50% of your car’s value. So, a title loan for your $6,000 car may only get you $1,500 at the interest rate of 25%.

When you repay your loan in full, the title is returned to you. However, if you can’t pay in full by the end of the loan term, the lender can take your car and sell it. Title loans have notoriously short terms and high annual percentage rates (APRs). You may have as little as two weeks to gather the money you need to repay your loan, y your loan, which includes interest and fees. To avoid losing your vehicle, you may end up taking out another loan, which is not a good idea. Like payday loans, title loans often lead to a cycle of debt that is difficult to escape.

Remember, collateral can be a helpful tool to access a range of financing options. Title loans aren’t dangerous because they require collateral, but because they have such challenging terms. In addition, unlike credit cards and personal loans, a title loan lender isn’t required to determine whether a borrower could realistically repay the debt.

If you need quick access to funds within your budget, you may want to consider a OneMain secured personal loan. Secured loans also require collateral, like a car. However, they have more reasonable repayment terms and lower APRs than title loans, making them easier to repay. Plus, you could get more money with a secured loan than an unsecured loan, which doesn’t require collateral.

Payday loans

If you need to buy groceries or pay rent but won’t have the cash until your next paycheck, you may be tempted to take out a payday loan. These loans typically consist of small amounts — several hundred to a thousand dollars — and require repayment when you get your next paycheck. They also come with inflated APRs, sometimes as high as 400%. If you can’t repay a payday loan in time, you may feel trapped into borrowing more money to cover it. Payday loans may lead to a cycle of debt that can have a damaging effect on your finances as well as your mental and emotional health.

If you need cash quickly, try to avoid payday loans. Instead, consider borrowing from a friend or family member. You may also apply for a personal loan from a trusted lender like OneMain Financial. Even if you have less-than-perfect credit, we’ll work with you to help you find the best fit for you.

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Approach all debt with care

Remember that the type of debt you have doesn’t define who you are as a person. It’s important to manage all debt responsibly and think carefully before you take it on. Before you open a new credit card account, apply for a loan, or take on any form of debt, you should consider how that debt could fit into your life. Good debt should bring you a step closer to your goals — without straining your finances. If debt does become challenging to manage, don’t wait to ask for help. You may be able to adjust your loan terms, refinance or consolidate debts to make your monthly bills easier to work with.

Sources:

1. https://www.fool.com/the-ascent/research/average-household-debt/ 2,6 https://cew.georgetown.edu/cew-reports/collegepayoff2021/
2. https://www.investopedia.com/terms/d/dti.asp
3. https://www.consumerfinance.gov/consumer-tools/mortgages/answers/key-terms/
4. https://www.fool.com/the-ascent/research/average-household-debt/
5. https://www.nerdwallet.com/article/loans/auto-loans/total-cost-owning-car