Good Debt vs Bad Debt: What's the Difference?
Not all debt destroys your finances. Some debt builds wealth while other debt drains it. Here's how to tell the difference.
By CashSmartGuide Editorial Team - Last updated: January 2026 | 7 min read
The blanket statement "all debt is bad" sounds wise but it's financially illiterate. Some of the wealthiest people carry millions in debt because they understand leverage. The difference isn't whether you have debt—it's what kind of debt you have and what it's doing for you.
Good debt puts money in your pocket over time or increases your earning potential. Bad debt drains money from your pocket to pay for things that lose value. One builds wealth, the other destroys it. Most people have both and don't realize which is which.
This guide breaks down exactly what separates good debt from bad debt, shows you which debts to prioritize paying off, and explains when taking on debt actually makes financial sense.
The Simple Distinction
Good debt has low interest rates, finances assets that appreciate or generate income, and increases your net worth over time. Examples: mortgages, student loans for high-earning degrees, business loans. Bad debt has high interest rates, finances depreciating assets or consumption, and decreases your net worth. Examples: credit card debt, car loans for expensive vehicles, personal loans for vacations. Good debt is a tool for building wealth. Bad debt is an anchor that prevents it.
What Makes Debt "Good" or "Bad"?
The classification isn't arbitrary. Four factors determine whether debt helps or hurts your financial future.
Factor 1: What You're Financing
Good Debt Finances:
- • Assets that appreciate (real estate)
- • Income-producing assets (rental property)
- • Education that increases earning power
- • Business investments that generate returns
Bad Debt Finances:
- • Depreciating assets (cars, electronics)
- • Consumption (vacations, restaurants, shopping)
- • Lifestyle upgrades you can't afford
- • Non-essential items that lose value
Factor 2: The Interest Rate
Interest rate matters as much as what you're buying. Even "good" purchases become bad debt at high rates.
- Low (acceptable): Under 7% - mortgage, student loans, some car loans
- Medium (questionable): 7-15% - fair but not ideal for any debt
- High (bad): Over 15% - credit cards, payday loans, most personal loans
Factor 3: Return on Investment
Good debt generates returns that exceed the interest cost. If you borrow at 4% to buy something that appreciates 6% annually or increases your income by 15%, that's good debt. If you borrow at 20% for something that provides zero financial return, that's terrible debt.
Factor 4: Impact on Net Worth
Track whether debt increases or decreases your net worth over time. A mortgage that builds equity increases net worth. Credit card debt for dining out decreases it. Simple but powerful distinction.
Examples of Good Debt
These debts can build wealth when used strategically. But even good debt can become bad if misused.
Mortgages
Buying a home you can afford with a reasonable mortgage is classic good debt. You're building equity instead of paying rent, home values typically appreciate, and mortgage interest rates are relatively low.
Why it's good:
- • Forces savings through equity buildup
- • Property usually appreciates over time
- • Tax deductible in many cases
- • Typically low interest rates
When it becomes bad:
- • Buying more house than you can afford
- • Using home equity to fund consumption
- • Buying in declining markets without research
Student Loans (For High-Value Degrees)
Education debt that significantly increases earning potential is good debt. A $40,000 loan for a degree that increases your lifetime earnings by $500,000+ is a solid investment.
Why it's good:
- • Dramatically increases earning potential
- • Relatively low interest rates
- • Flexible repayment options
- • Investment in yourself
When it becomes bad:
- • $100k debt for low-paying field
- • Not finishing the degree
- • Expensive private school when state school offers same outcome
Business Loans
Borrowing to start or expand a profitable business is leveraging debt to create income. If the business generates returns above the loan interest, you're using debt as a wealth-building tool.
Why it's good:
- • Creates income-generating asset
- • Can generate returns far exceeding interest
- • Tax deductible interest
Examples of Bad Debt
These debts drain wealth and should be avoided or paid off aggressively.
Credit Card Debt
Carrying balances on credit cards is almost always bad debt. Interest rates of 15-25% compound faster than virtually any investment can grow.
Why it's terrible:
- • Extremely high interest rates (15-25%)
- • Finances consumption, not assets
- • Compounds rapidly if unpaid
- • No tax benefits
Learn more: How Credit Card Debt Hurts Your Financial Future
Payday Loans
The worst type of debt. Effective annual interest rates often exceed 300%. These create debt spirals that are incredibly difficult to escape.
Car Loans (For Expensive Vehicles)
Cars are depreciating assets. Financing an expensive car you can't afford creates bad debt. A $40,000 car loses $10,000 in value immediately while you're paying interest on the full amount.
Personal Loans for Consumption
Borrowing money for vacations, weddings, furniture, or other consumption is bad debt. You're paying interest to finance lifestyle you can't afford.
Which Debt Should You Pay Off First?
When you have multiple debts, attack them in this order regardless of the good/bad classification.
Payday Loans & High-Interest Personal Loans
Anything over 20% interest. These are financial emergencies. Pay them off immediately.
Credit Card Debt
15-25% rates compound too fast. Attack these aggressively.
Car Loans & Personal Loans
Usually 5-12% rates. Pay these down next.
Student Loans
Usually 4-7% with flexible repayment. Pay these steadily but don't rush.
Mortgage
3-7% rates. Pay this last once all bad debt is gone.
Strategy note: For detailed payoff methods, see: Debt Snowball vs Debt Avalanche
The Bottom Line
Good debt finances assets that appreciate or generate income, carries low interest rates, and builds your net worth over time. Bad debt finances consumption or depreciating assets, carries high interest rates, and drains your wealth through compound interest.
Most people have both. The goal isn't zero debt—it's zero bad debt. Pay off credit cards, payday loans, and high-interest personal loans aggressively. Take your time with low-interest mortgages and student loans while investing simultaneously.
Before taking on any new debt, ask yourself: Does this increase my income or net worth over time? If yes and the interest rate is reasonable, it might be good debt. If no, it's bad debt you'll regret.
The wealthy understand that strategic debt is a tool for building wealth. The broke treat all debt the same and either avoid it completely or use it to finance consumption. Know the difference, and use good debt strategically while eliminating bad debt ruthlessly.
Master Your Debt Strategy
Financial Advice Disclaimer
This article provides general information about debt types and management strategies. It should not be considered personalized financial advice. Your debt situation, goals, and risk tolerance are unique and may require professional guidance. The classifications of "good" and "bad" debt are generalizations that may not apply to every individual circumstance. Consider consulting with qualified financial advisors, credit counselors, or debt specialists for advice specific to your situation.