Good vs. Bad Debt and What Debt Means for You

Some people assume that all debt is bad and should be avoided at all costs. However, debt can be both good and bad because of how it’s handled as a strategic means to better financial health.

For example, some debt has long-term financial benefits, while other types of debt lead to negative consequences and cycles of ongoing money problems.

In this Tower Loan article, we explore the good and bad aspects of debt and provide examples of each type to help you better understand how to manage debt responsibly.

What Is Good Debt?

The definition of good debt is debt that a person takes on to achieve personal goals or long-term financial growth. Debt is considered to be good if it is managed well and if it opens the door to new opportunities. However, there is no guarantee that good debt will always stay good. 

Characteristics of Good Debt

Good debt often comes with lower interest rates and manageable payments you can repay over time. It also gives you the potential to increase your net worth in the future. You might take on good debt to own a home, earn an educational degree, or start a new company.

Examples of Good Debt  

A mortgage is an example of good debt because it builds equity and housing security. Other examples of good debt are student loans, business loans, and automobile loans.

Student loans are investments in your future career and future earning potential. A business loan can help you launch or expand your business to generate revenue and make more money in the future. Meanwhile, an auto loan enables you to pay for necessary transportation to get to school or your job for future employment opportunities.

Personal loans, like the ones we offer at Tower Loan, can also be good debt because they can help consolidate debt with lower interest. If you qualify for an unsecured loan, you won’t even have to put up collateral like a car or house to secure the financing.

Another example of good debt is an interest-free loan if you are fortunate enough to secure one. Some people can get interest-free loans from trusted friends or family members. You might also be able to get a loan without energy by making energy-efficient upgrades to your home. Some nonprofit organizations and charitable foundations offer interest-free loans to students pursuing their education and to business owners pursuing socially responsible enterprises that will benefit their communities.

If you refinance an existing debt with a new loan, this strategic move could be considered good debt. Refinanced debt, such as a home equity loan or line of credit, could make monthly payments more manageable.

What Is Bad Debt?

On the flip side, the bad debt definition describes debt that offers little or no financial benefit and is difficult for a borrower to pay back. Bad debt provides no long-term gains and often comes with repayment terms that negatively impact you.

Signs of Bad Debt

High interest rates and unaffordable monthly payments typically accompany bad debt. When you take on bad debt, it sets you back financially and harms your credit health.

Any debt that you can’t afford is a bad debt. What’s good debt for one person could be bad for someone else based on their unique financial situations and spending habits.

What Is Considered Bad Debt?

One potential example of bad debt is credit cards, especially when the card you choose has high interest rates if you don’t pay the balance in full each month. Payday loans are considered to be bad debt because these short-term loans come with high fees and interest. They also often lead to recurring cycles of debt that are difficult to break out of.

If you use debt for discretionary purposes, it can be classified as bad debt because it’s not essential. Examples include luxury items like high-price sports cars, over-the-top vacations, and designer clothing.

If a debt negatively affects your credit score, it may be a bad debt. This could happen if you don’t manage your debt well or if you fall behind on payments.

The Gray Area: Debt That’s Neither Good Nor Bad

However, some types of debt are more neutral and can’t be called either good or bad. “Gray area debt” exists, but the needle can move towards good or bad depending on how it is used or repaid. Here are some examples.

Examples of Gray Area Debt

Credit cards are an example of a gray area of debt because they can build your credit when adequately managed. However, they can also be harmful to your credit if you don’t pay your balances. Credit cards give you financial flexibility to pay for what you need quickly. But look for cards with a promotional APR to keep interest charges down or a rewards card that gives you cash back for items you buy. If you can afford to pay off your credit cards each month, aim to do so because this saves you money on interest.

Similarly, Buy-Now, Pay-Later plans can be helpful for spreading out payments over time. However, they can also be risky if you overuse them frequently when you don’t really need to.

Auto loans are a form of neutral debt as long as the interest rates are low. They enable you to access necessary transportation, but they can be risky if you use them for luxury purchases or multiple vehicles that you don’t truly need for essential drives.

How Good Debt Can Turn Into Bad Debt

Even debt that starts off good can turn bad over time if you mismanage it. If you miss payments on a good debt, it can harm your financial health and put you in a worse financial position than you were before taking out the debt.

One example of how a good debt can turn bad is if you miss a mortgage payment on your home. If you fail to manage your student loans after graduating from college, you could also be setting yourself up for a bad debt situation.

How to Avoid Bad Debt

To find a balance between good vs. bad debt, it’s essential to avoid bad debt as much as possible in your daily transactions and future financial planning. Here are some suggestions.

Create and Stick to a Budget

One of the best ways to get on a good financial path is to create a budget that details your monthly expenses, income, and debt load. Make sure that any new debt you take on can fit within your current financial capacity. Assess your current monthly payments and ask yourself the honest question of whether you can realistically afford another monthly bill.

Once you create your budget, do everything in your power to stick to it. Keep your budget handy on a mobile app or printed out in your home so that you see it regularly as a reminder of good spending habits and long-term goals. Discuss your budget with your family and household members for accountability.

Start Saving for an Emergency Fund

It’s also a wise idea to start building an emergency fund so that you are prepared when unexpected expenses and emergencies strike. If you have a cash reserve built up to protect yourself, you may be able to avoid high-interest loans when you feel desperate for quick cash and aren’t sure where to turn.

It’s a good idea to put emergency fund savings into a high-yield savings account so that it earns interest over time and is easily accessible whenever you urgently need it without paying fees to take it out.

Improve Your Credit:

If you can boost your credit score, you will be in a better financial position to handle your money and find good loans that lead to good debt. People with good credit are often eligible for lower interest rates and better terms when they need to take out loans.

Another idea is to use Experian Boost to get credit for utility, rent, and cell phone bills. If you build your credit history, lenders will see that you are financially reliable. Expanding your credit file could result in more loan and card offers to choose from.

Envision Your Future Goals

It’s easy to get caught up in the moment when you need money quickly and can’t afford what you want outright. However, take a step back and try to gain some perspective when this happens. Consider your long-term goals and decide whether borrowing additional money now will help you achieve them.

If the new debt factors into your plans for making more money or living more comfortably in the future, it may be a good debt to take on now. If the new debt you’re considering only fulfills a short-term need and doesn’t match your broader life goals, perhaps now is not the right time to pursue it.  

Tips for Managing Debt Responsibly

Now that you have a more thorough understanding of good debt vs. bad debt, you can start putting this knowledge into practice for a responsible financial life.

Here are some debt management tips from the financial professionals at Tower Loan:

• Consolidate debt whenever possible to reduce interest rates
• Pay off high-interest debt first to save more on your payments
• Review your debt-to-income ratio regularly to assess changes
• Track your spending so you know where to cut corners reasonably
• Always make payments on time
• Automate your payments so you never miss one
• Only take on new debt when you absolutely need to
• Pay more than minimum payments to pay off debt faster
• Increase your income by picking up side gigs or freelance work
• Consider debt management counseling with a financial professional
• Contact Tower Loan to learn about how personal loans can help with debt

It is more practical to manage your existing debts now rather than take on new debt and have to get yourself out of it. Organizing your debts, comparing payoff strategies, and setting priorities can get you on the right track to living with less debt.

Fortunately, help is available if you need it through responsible lenders, nonprofit credit counseling agencies, financial counselors, and financial assistance programs. Proper debt management can help you avoid having to settle debts that harm your credit or filing for bankruptcy.

How Tower Loan Can Help with Debt Management

As you now know, there are distinct differences between good debt vs. bad debt. Good debt helps you improve your financial situation and build wealth, while bad debt is challenging to manage and does not get you to a better financial place for the future.

Responsible debt management is crucial for long-term financial health, so don’t be afraid to reach out to trusted financial professionals if you need some guidance about good vs. bad debt.

Tower Loan can assist you with personal installment loans and debt management so you can pay for home improvements, vacations, or something you need urgently. Our online loans are a fast and convenient way to borrow money when you face car repairs, medical bills, or other urgent expenses.

We have an extensive network of branch offices in six states staffed with knowledgeable professionals who will listen to your unique needs and help you find a good debt solution that works for you. To get started, apply online today or visit or call the local branch nearest you.