Good Debt Versus Bad Debt
Managing debt is a crucial part of your financial responsibilities. Good debt can be used smartly to achieve your financial goals. Bad debt is what you get when you buy things you may not need with money you don't have.
Commit to financial freedom by knowing the difference between good debt and bad debt — and how to manage both.
What is good debt?
Good debt is that which translates into an investment with long-term growth potential. You usually take on good debt after careful consideration and with a clear plan for repaying it. Here are a few examples:
- Buying a house. Mortgage debt is good debt, and buying a home can be a good long-term investment, depending on how its value appreciates. Interest rates on home loans are generally low, and mortgage interest is tax-deductible.
- Paying for college. A college degree increases your earning potential, so student loans are typically considered to be good debt. Student loans generally have low interest rates and a grace period on repayments until after graduation.
- Buying a car. This one can be good or bad debt, depending on what type of car you buy. Cars rarely maintain long-term value (it's almost always the opposite), but they can still be a good investment based on your need for a car and the reliability of the one you buy.
What is bad debt?
Bad debt can pile up when you buy things that quickly lose their value and don't have any long-term growth potential. You risk having to pay back significantly more money than you borrowed in the first place. Even worse, bad debt can negatively affect your credit score, especially if you've maxed out several credit cards or have bills you can't afford to pay. Here are some examples of bad debt:
- Goods and services. Things that decrease in value or get consumed — like clothing, food, gas or vacations — end up costing you more in the long run because the interest keeps adding up.
- Credit cards. Interest makes a big difference here, too. If you carry credit card balances instead of paying them off in full each month, you'll pay way more than what the items actually cost. Credit card companies often lure customers in with low or zero interest rates for the first year, then charge a higher-than-average interest rate at the end of the promotional period.
- Payday loans or cash advance loans. Avoid these loans at all costs. You'll likely pay a fee to get the loan upfront, and the interest rates can be as sky-high as 300 percent.
- Furniture, appliances and home remodeling. It's tempting to borrow money for these big-ticket items. A better plan is to save for these things and avoid going into debt at all.
Knowing the difference here can help you gain control over your finances to build toward a debt-free future. Free financial guidance is available to service members through Military OneSource where you can connect with a counselor to make a plan.