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Good Debt vs. bad debt: Know the Difference
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Good Debt vs. Bad Debt: Be aware of the distinction
Credit can be a great way to achieve goals, while bad debt is expensive and can derail them.
By Sean Pyles Senior Writer | Personal finances, debt Sean Pyles leads podcasting at NerdWallet as the producer and host of NerdWallet's "Smart Money" podcast. The show "Smart Money," Sean talks with Nerds across the NerdWallet Content team to answer listeners' questions about personal finance. With a particular focus on sensible and actionable financial advice, Sean provides real-world guidance that can help consumers better the financial situation of their lives. In addition to answering listeners' financial concerns on "Smart Money" Sean also interviews guests who are not part of NerdWallet and also creates special segments on topics such as the racial gap in wealth, how to start investing and the background for student loans.
Before Sean took over podcasting at NerdWallet, he covered topics that dealt with consumer debt. His writing has been featured in USA Today, The New York Times and other publications. When when he's not writing about personal finances, Sean can be found digging around his garden, taking walks, or taking his dog on long walks. He is based in Ocean Shores, Washington.
Updated on Feb 21, 2023
Written by Kathy Hinson Lead Assigning Editor Personal finance, credit scoring, managing money and debt Kathy Hinson leads the Core Personal Finance team at NerdWallet. Previously, she spent 18 years working at The Oregonian in Portland in roles including copy desk chief and team director of design and editing. Her previous experience includes news and copy editing for various Southern California newspapers, including the Los Angeles Times. She received a bachelor's degree in journalism and mass communications at Iowa's University of Iowa.
The majority or all of the products we feature are from our partners, who pay us. This affects the products we write about as well as the place and way the product appears on a page. However, this does not affect our opinions. Our opinions are entirely our own. Here's a list and .
Before taking on any kind of debt, think about whether a car loan or new credit card will be able to help you achieve your financial goals or make them more difficult to achieve. The debt you commit to as well as the amount and cost, can mean the difference between bad debt and good debt.
A credit card, for example, is a means to financing large expenditures and earn reward points. If not handled properly, credit card debt with high interest rates can become out of control.
Here are some general guidelines for good debt and bad debt and what to do when you're faced with an excessive amount of debt.
What is good debt?
A low-interest loan that can help increase your earnings and net worth can be examples of good debt. But too much of debt -- no matter the opportunity it could create can turn it into bad debt.
Medical debt, for instance isn't a neatly categorized in the "good" or "bad" debt categories. It's an expense that's insurmountable, and usually doesn't come with any interest. You have .
Student loans
Generally, they are viewed as an investment in the future and future, student loans generally be lower in interest rate, specifically in the case of federal student loans.
Guideline: In general, aim for your student loan payments to not exceed 10% of the projected annual after-tax earnings after you graduate. If you expect to earn $50,000 per year, the annual borrowing limit would be $29,000.
Action: To deal with overburdened student loans take a look at options the possibility of refinancing or the repayment plan that is based on income.
Mortgages
Likely the biggest financial decision you'll make, a loan is the path to homeownership.
Guidelines: Be aware prior to shopping and limit your mortgage payment up to 36% of earnings.
Make a move: downsizing and/or moving into a less expensive area could make housing costs more manageable.
Car loans
For many, a car is essential for everyday life.
Guideline: Keep total auto costs, including your car loan payment, . The loan terms must be 4 years or less, but usually with 20% down.
Make a move: trading in a car that isn't affordable will help you control costs for your car.
Make sure you track your debt the simple method
Sign up to NerdWallet to see your debt breakdown and the next installments all in one spot.
What is bad debt?
The burdensome debts that eat away at your financial standing are classified as bad debt. Examples are debts that have significant or variable interest rates particularly when they are used for discretionary expenses or things that lose value.
Sometimes bad debts are bad debts that have gone wrong. The credit card is an illustration that shows this. If you own a high-interest credit card and pay down your balance every month, it's fine. But if high-interest credit card debt accumulates over time, you could find yourself in danger.
Credit cards with high interest
The high interest rates like those that are higher than 20%, can make your debts more expensive.
Guidelines: If you're not making progress on paying off your debts with credit cards regardless of making sure you pay it all monthly, that may be a sign that you're experiencing problems .
Do something about it: If you can manage your spending Try the strategy which is where you pay off the smallest debts first. It can make your credit card debt more affordable however, you'll need to have good credit score to qualify for. In other cases, a nonprofit credit counseling agency may be an alternative.
Personal loans to fund discretionary purchases
Taking on debt for expenses like a vacation or new clothes could be an costly habit.
Guideline: Personal loans can be a good option when you have a particular objective in mind, like .
Do something about it If you're faced with an expense for a personal loan You might be in a position to .
Payday loans
are a bad debt which can become toxic. They are usually accompanied by interest rates as high as 300% which could make them immediately unaffordable. These are small-sized, short-term loans designed to be repaid with your next paycheck.
Guidelines: Financial experts warn against payday loans since borrowers could easily be entangled in an unsustainable cycle of debt.
Take action: Consider alternatives like borrowing from an institution like a credit union, or asking family members for assistance.
About the author: Sean Pyles is the executive producer and host of the NerdWallet's Smart Money podcast. His writing has been featured on The New York Times, USA Today and elsewhere.
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