Highlights:
- Some types of debt can be advantageous if managed responsibly
- "Bad debt" can be any debt you're unable to repay
- Learn steps you can take to avoid bad debt
Did you know there actually can be such a thing as good debt? Many people mistakenly think all debt is bad, but there are certain types of debt that can be advantageous when it comes to your credit.
So, what is “good debt"?
Speaking generally, debt that you're able to repay responsibly based on the loan agreement can be "good debt," as a favorable payment history (and showing you can responsibly handle a mix of different types of debt) may be reflected in credit scores. In addition, "good" debt can be a loan used to finance something that will offer a good return on the investment. Examples of good debt may include:
Your mortgage.You borrow money to pay for a home in hopes that by the time your mortgage is paid off, your home will be worth more. In some cases, you can deduct the interest on mortgage debt on your taxes. Home equity loans and home equity lines of credit — which are a type of loan in which a borrower uses his or her home as collateral– may also be considered a form of good debt. The interest payments on these are tax-deductible as long as you use the loan for its intended purpose: to buy, build or renovate the home used as collateral.
Student loans can be another example of “good debt.” Somestudent loans have lower interest rates compared to other loan types, and the interest may also be tax-deductible. You’re financing an education, which can lead to career opportunities and potentially increasing income. However, a student loan becomes a bad debt if the loan is not paid back responsibly or within the terms agreed upon. It can also become burdensome if you have so much student loan debt that it takes years (and more interest payments) to repay.
Auto loans can be good or bad debt. Someauto loans may carry a high interest rate, depending on factors including your credit scores and the type and amount of the loan. However, an auto loan can also be good debt, as owning a car can put you in a better position to get or keep a job, which results in earning potential.
What is “bad debt”?
Simply put, “bad debt” is debt that you are unable to repay. In addition, it couldbe a debt used to finance something that doesn’t provide a return for the investment. Debt could also be considered "bad" when it negatively impacts credit scores -- when you carry a lot of debt or when you're using much of the credit available to you (a high debt to credit ratio).
Credit cards, particularly cards with a high interest rate, are a typical example. If you can’t pay your credit cards in full every month, interest payments can prolong the debt.
High-interest loans -- which could include payday loans or unsecured personal loans -- can be considered bad debt, as the high interest payments can be difficult for the borrower to pay back, often putting them in a worse financial situation.
What to Do to Avoid Bad Debt
If you’re making a purchase that increases your debt,ask yourself how this purchase will benefit you – not just today, but long term. Is the debt you’ll incur going to provide you a lasting benefit, or is it something that will satisfy an immediate desire that you can’t afford?
It’s also a good idea to have a rainy-day or emergency fund for unexpected expenses, so you won’t have to use credit cards to pay them.
Try to keep your debt to credit ratio (the ratio of how much you owe compared to the total amount of credit available to you) as low as possible to avoid being viewed as a risky borrower by lenders. Focus on paying the debt you have and restrict new purchases.
Lastly, it’s always important to pay your bills on time, every time.
FAQs
Debt can be good or bad—and part of that depends on how it's used. Generally, debt used to help build wealth or improve a person's financial situation is considered good debt. Generally, financial obligations that are unaffordable or don't offer long-term benefits might be considered bad debt.
Is a car loan good or bad debt? ›
Some auto loans may carry a high interest rate, depending on factors including your credit scores and the type and amount of the loan. However, an auto loan can also be good debt, as owning a car can put you in a better position to get or keep a job, which results in earning potential.
What is considered bad credit debt? ›
A person or business is considered to have bad credit if they have a history of not paying their bills on time or they owe too much money. Bad credit for individuals is often reflected in a low credit score, typically under 580 on a scale of 300 to 850.
How do you differentiate good and bad credit? ›
Simply put, “Good credit is credit that you can afford and use to buy things that you need. Bad credit is credit that you can't afford and you use it for things that you don't need,” says Lebogang Selibi, Media Relations Officer for the National Credit Regulator.
Is a mortgage a good or bad debt? ›
Mortgages are seen as “good debt” by creditors. Since the mortgage debt is secured by the value of your house, lenders see your ability to maintain mortgage payments as a sign of responsible credit use. They also see home ownership, even partial ownership, as a sign of financial stability.
What is bad debt for dummies? ›
Bad debt refers to loans or outstanding balances owed that are no longer deemed recoverable and must be written off.
What are examples of good debt? ›
Examples of good debt are taking out a mortgage, buying things that save you time and money, buying essential items, investing in yourself by borrowing for more education or to consolidate debt. Each may put you in a hole initially, but you'll be better off in the long run for having borrowed the money.
What is an example of a bad debt? ›
Bad Debt Example
A retailer receives 30 days to pay Company ABC after receiving the laptops. Company ABC records the amount due as “accounts receivable” on the balance sheet and records the revenue. However, as the 30 day due date passes, Company ABC realises the retailer is not going to make the payment.
Is a line of credit good or bad debt? ›
Lines of credit, like any financial product, have advantages and disadvantages, depending on how you use them. On one hand, excessive borrowing against a line of credit can get you into financial trouble. On the other hand, lines of credit can be cost-effective solutions to fund unexpected or major expenses.
How to get an 800 credit score? ›
Making on-time payments to creditors, keeping your credit utilization low, having a long credit history, maintaining a good mix of credit types, and occasionally applying for new credit lines are the factors that can get you into the 800 credit score club.
Highlights: While older models of credit scores used to go as high as 900, you can no longer achieve a 900 credit score. The highest score you can receive today is 850. Anything above 800 is considered an excellent credit score.
What is the poorest credit score? ›
Well, there are several credit score ranges. For instance, 780–850 may be considered "excellent" while 720–780 may be seen as "good." But when it comes to a range that may be seen as bad, a score between 300 (the lowest) and 660 fits into the “poor” category.
What is the lowest FICO score you can have? ›
The lowest score you can get with either model is 300, though past scoring models have gone lower (and aren't used so much today). According to FICO, an estimated 11.1% of Americans have a FICO score ranging between 300 and 549 as of 2019.
Why is bad credit better than no credit? ›
Having no credit is better than having bad credit, though both can hold you back. Bad credit shows potential lenders a negative track record of managing credit. Meanwhile, no credit means lenders can't tell how you'll handle repaying debts because you don't have much experience.
What is better than good credit? ›
For a score with a range between 300 and 850, a credit score of 700 or above is generally considered good. A score of 800 or above on the same range is considered to be excellent. Most consumers have credit scores that fall between 600 and 750. In 2022, the average FICO® Score☉ in the U.S. reached 714.
What is good and bad debt in business? ›
Good debt drives your business forward, helping you to grow faster, while bad debt can constrain growth or even threaten the survival of your company. A smart approach to good and bad debt means reviewing your debts and prioritising repayments.
How much debt is considered bad debt? ›
Key takeaways
Debt-to-income ratio is your monthly debt obligations compared to your gross monthly income (before taxes), expressed as a percentage. A good debt-to-income ratio is less than or equal to 36%. Any debt-to-income ratio above 43% is considered to be too much debt.
Is bad debt a loss or profit? ›
Bad debt is the amount owed to a company by a customer who cannot make payments and is typically written off as a loss.
