All debt isn’t created equal.
Generally, debt is broken down into two categories: good and bad.
The categories aren’t based on how you feel about taking on that debt, but rather how it affects your credit and your finances.
Good debts tend to have lower interest rates — capped at about 6% — while interest rates for bad debt tend to be higher.
Debts that are generally considered good include:
- Student loans
- Business loans
Debts that are generally considered bad include:
- Credit cards
- Car loans
- Consumer loans
See any patterns?
The debts that are considered “good” could also be seen as investments in yourself: You’re borrowing that money to build equity in a place to live, to pay for an education that increases your earning potential, or to create an income-producing business.
The “bad” debts, on the other hand, are used to pay for things that won’t create more value for you in the long run, like a car (it’s no secret that new cars start depreciating in value the minute they exit the dealership), a credit card bill, or consumer loans with high interest.
The classification of good or bad isn’t delineated in your credit report, so you do have the power to turn bad debt into good — or the reverse. If you’re making regular, full payments on any of the debts above, it shouldn’t negatively impact your credit. But if you’re making late or incomplete payments, even good debt can turn bad.
Largely, financial experts use the designation of bad debt to indicate that which a borrower should prioritise paying off, often because it comes with higher interest rates that will extract more money from you the longer you let it linger.