Is Good Debt a Real Thing?
Debt is very common. In fact, 80 percent of Americans have a moderate to substantial amount of debt —more than $96,000 each according to Experian's review of credit data. And while the cause of said debt varies—some individuals are indebted to mortgage lenders, others owe medical or credit card providers or student loans—the root of the debt doesn't matter. Not really. Because debt is debt; it's money owed. But is there such a thing as "good debt?" According to Lisa Smith of Investopedia, good debt exists, but it's not quite black and white.
"There certainly is an argument to be made that no debt is good debt," Smith says. "But borrowing money and taking on debt is the only way many people can afford to purchase important big-ticket items like a home. While those kinds of loans are usually justifiable and provide value to the person taking on the debt, there is another end of the spectrum that involves debt that's taken on carelessly. While it's easy to differentiate between these two extremes, some other debts are harder to judge."
Historically speaking, debt has been divided into two categories: good debt and bad debt. But of course, "not all debt can be classified as good or bad so easily," Smith adds. "Often it depends on your own financial situation or other factors. Certain types of debt may be good for some people but bad for others."
"Good debt is defined as debt taken out for an asset that increases in value or increases your ability to build wealth," R.J. Weiss, a certified financial planner, explains. "Good debt can be tangible, such as a home, or intangible, such as the case with taking out a student loan."
Supposed "bad" debt, however, refers to debt that does little to improve your financial outcome—credit cards, car loans, or personal/payday loans, for example.
Types of Good Debt
Mortgage(s)
Home equity loans and/or lines of credit
Student loans
Small business loans
These are, of course, oversimplifications. The distinctions between good and bad debt are a lot more nuanced. "Not all houses go up in value, for example, and... education isn't always worth the investment," Weiss says. If you cannot find a job post-graduation, for example, having tens of thousands of dollars in student loan debt may not make sense. "What seems like good debt today, can indeed be bad debt," Weiss adds. "With both good and bad debt, there is risk." However, there are benefits to having good debt.
"Good debt can help you build wealth," Weiss explains. "Whether that's through increasing your ability to earn money or having an asset that increases over time, the idea with good debt is that long-term you'll be better off for having taken on the debt." And Parvesh Benning, a financial advisor, agrees, adding that "good debt gives you leverage and further gains, whether it be through investment returns or education."
What's more, sometimes borrowing money is your only option. "No one likes financing a purchase and/or leasing a car because we all know the car drops in price the moment you drive it out of the dealership," Pam Krueger, a financial advisor and the CEO and founder of Wealthramp, explains. "But sometimes it is a necessity."
So how much debt is good debt? Well, while there's no number or ratio that works for everyone, Krueger offers a benchmark: "When your debt amounts to more than 40 percent of your total income, it's considered high," Krueger says. "This is what lenders will look at when you're applying for a mortgage, for example. It's a baseline number." But that doesn't mean it's the end-all-be-all.
The bottom line: "Debt is relative, situational, and very specific," Benning says. "Can you comfortably service the debt? In the case of student loans, is it debt that you can pay off in a reasonable time?" These are all factors to consider when weighing the cost/benefit ratio of debt.
But no matter what, remember: Your debt does not make you a bad person. Some of it might even help you—and even the "bad" debt can be paid off, likely easier than you might think. Here's a place to start.
