Good Debt vs. Bad Debt: What’s the Difference?

What Is Good Debt?

Good debt tends to be debt that allows someone to achieve meaningful personal goals or could lead to long-term financial gain.

For example, someone who wants to become an attorney will likely need to borrow a lot of money for law school. They might graduate with over $100,000 in debt, but the loans allow them to achieve their dream and potentially set them on a path toward a lucrative career.

Examples of Good Debt

Although what counts as good debt may be subjective, some common examples include:

• Mortgages: Buying a home can offer housing security and stability, and home ownership can be an important way to build wealth. Most people need to take out a loan that's secured by their home—a mortgage—to purchase a home. They build equity, or ownership, in the property as they pay off the loan.
• Student loans: A student loan can help you pay for vocational training or degree-granting programs. There are federal student loan programs that don't require good credit and offer relatively low interest rates. Private student loans might be a worse option because they could have higher interest rates, fewer repayment options and aren't eligible for many federal forgiveness programs.
• Business loans: Starting a business often requires a large initial investment, and running or growing a business can require additional business loans or lines of credit. These could be classified as good debt when they allow you to create a business that supports you and your employees.
• Interest-free loans: You might qualify for an interest-free loan for certain types of purchases. For example, you might receive an interest-free loan to make energy-efficient home improvements or as part of a down payment assistance program. Some nonprofit organizations also offer interest-free loans to students, small business owners and people who want to improve their credit.
• Refinanced debt: Refinancing existing debt with a new loan or line of credit could be a strategic move that saves you money or makes your monthly payments easier to manage. Some people use a home equity line of credit, home equity loan, personal loan or balance transfer credit card to refinance and consolidate debts.

What Is Bad Debt?

You might classify debt as bad debt based on how the borrower uses the money, the debt's terms or whether the debt will yield long-term benefits.

For example, if you take out a loan for discretionary purchases, such as a vacation or shopping, you could end up paying significant interest charges over time. That might be considered a poor use of debt. A debt that has a high interest rate or fees could also be considered bad debt, even if you use the debt for an essential purchase.

One way to compare loans is to calculate the annual percentage rate (APR) of the various options to see which one will cost more on an annualized basis. A loan's APR considers the interest rate, certain fees and repayment term.

Examples of Bad Debt

Some common examples of bad debt include:

• Credit card debt: Credit cards often have high interest rates, so carrying credit card balances (instead of paying them off each month) could be considered bad debt.
• High-interest loans: Loans that have unusually high fees or interest rates include high-rate installment loans that you find online, payday loans and auto title loans.
• Debt for discretionary spending: Taking out a loan to pay for a vacation, designer clothing, hobbies or other discretionary spending could be considered bad debt.

It's often best to avoid certain types of loans and borrowing money when you don't need to. Otherwise, you could wind up in a debt cycle, where you have to continually take out new loans to afford all your bills.

Somewhere-in-the-Middle Debt

Sometimes, debt falls into a gray area—it's not quite good or bad.

For example, credit card debt is often considered bad debt. However, you won't have to pay interest on your purchases if you pay your credit card bill in full each month. You also might get a card that has a 0% intro APR offer and you can pay off your purchase over time without paying any extra fees or interest. Debt that doesn't accrue interest generally falls under good debt.

Buy now, pay later (BNPL) plans could also be good debt because they let you pay off purchases without any added interest or fees. But taking on too many BNPLs or using BNPLs to purchase things you couldn't otherwise afford could lead to trouble.

Even a vehicle loan could be in the gray zone. It might be considered good debt if you get a low interest rate and use the loan to purchase a primary vehicle. But it might be considered bad debt if you're borrowing money to buy a second car or a boat, and the loan payments make covering your day-to-day expenses difficult.

Often, the specific terms, how you're using the money and the entirety of your financial situation determine if a new debt will be good or bad.

How to Avoid Bad Debt

Avoiding bad debt is sometimes a choice—you can decide whether you'll borrow money to pay for a vacation or wait until you save up enough. Other times, you might have to take on high-interest loans to care for your family and pay for necessary expenses. You can try to avoid either situation if you:

• Create a budget: Following a budget, even a bare-bones one, can help you identify how much you need for necessary expenses and you might discover you're spending more than you expected on certain discretionary expenses. You may be able to find ways to save money and use those savings rather than taking on debt.
• Improve your credit: A good credit score can help you qualify for credit cards and loans with favorable terms. If you focus on paying your bills on time, using credit accounts could help you build credit. You can also look for ways to build credit without taking on new debts, such as using Experian Boost^®ø to add eligible rent, utility, streaming service and insurance payments to your Experian credit report.
• Build an emergency fund: Slowly set money aside until you have at least three to six months' worth of living expenses in an emergency fund. You can use this money instead of taking out bad debt when an emergency arises. And you can keep the fund in a high-yield savings account to earn higher interest on your savings.

Learn more >> How to Improve Your Credit Score

How to Get Out of Debt

If you're feeling overwhelmed with debt—good or bad—here are five steps you can take:

1. Organize Your Debts

First things first: If you're managing multiple loans and credit cards, create a list with all your debts. Write down how much you owe, the minimum monthly payment and the interest rate for each account.

2. Compare Debt Payoff Strategies

Look into various debt payoff strategies to see if one stands out as a realistic and helpful option.

For example, you might focus on the account that has the highest interest rate or the account with the lowest balance first—using the debt avalanche or debt snowball strategy, respectively. Or, you could look into consolidating multiple debts into one new loan that has a lower interest rate or monthly payment than your current accounts.

Your options might depend on your credit and how much money you have left in your budget every month.

Learn more >> How to Get Out of Debt on a Low Income

3. Set Priorities

Getting out of debt can require tough decisions. You might need to cut back on niceties, or even reduce expenses that you'd prefer to consider necessities. Or, you might have to find ways to make money that you can use to pay down balances. Prioritizing your financial health and what that entails might be challenging, but it's an important step in reducing your debt.

4. Look for Support

Find professional help if you're unsure of what to do or you can't make your budget add up.

• Financial therapist or counselor: A financial counselor or financial therapist could be a good option if you're struggling to control your spending or want to better understand your relationship with money.
• Nonprofit credit counseling agencies: Credit counselors can help you create or optimize your budget. If you're overwhelmed by unsecured debt, such as credit card debt, they also might be able to set you up with a debt management plan (DMP). With a DMP, the counselor might be able to negotiate to help you save money, lower your monthly bills and get on a manageable path toward paying off the debt.
• Financial assistance programs: A financial assistance program might help you lower or pay for necessary expenses, such as utilities and food. You can then use the savings to pay down debts.

5. Face Hard Decisions

If circumstances make it impossible for you to pay off the debts, you may need to consider:

• Settling past-due debts: If you've fallen behind and are dealing with past-due debt or a collection agency, you may be able to settle your debt for less than the outstanding balance. Settling your debt might be better for your credit than leaving a bill unpaid, and it will stop debt collectors from calling, but it's worse for your credit than repaying the debt in full.
• Filing for bankruptcy: Filing for Chapter 7 bankruptcy could help you clear away debts and get a fresh start. A Chapter 13 bankruptcy might get you on a three- to five-year payoff plan, but let you keep more of your possessions. Both options could hurt your credit for years to come.

While these might be a last resort, they can help you get out from under overwhelming debt and your credit could eventually recover.

Improve Your Credit to Get Better Loan Offers

Improving your credit might help you qualify for better credit offers and save money, even if you have to take on bad debt. You can get your FICO^® Score^☉ and credit report for free from Experian, and get complimentary ongoing credit monitoring. You can also use your account to learn what's affecting your credit score, how to improve your credit and get matched with loan and credit card offers.