Good debt vs bad debt: when borrowing makes sense
Some borrowing builds your future; some drains it for years. How to tell good debt from bad debt before you sign.
Not all debt is the same. Some borrowing can improve your life and your finances over time, while other borrowing quietly drains your income for years. Knowing the difference between good debt and bad debt helps you decide when borrowing makes sense, how much to borrow and when to say no. This guide explains what separates good debt from bad debt, the questions to ask before you borrow, and why even "good" debt can become a problem.
What makes debt "good"?
Good debt is borrowing that helps you build income or lasting value that is greater than the cost of the loan. Classic examples include a reasonably priced loan for education or training that raises your earning power, a business loan for equipment or stock that will clearly increase sales, and a home loan you can comfortably afford on a property you will live in for years. In each case, the money borrowed is expected to return more than the interest and fees you pay.
Good debt also has fair terms: an interest rate you understand, repayments that fit your income, and a clear end date.
What makes debt "bad"?
Bad debt usually pays for things that lose value quickly or are consumed immediately, often at a high interest rate. Examples include using credit cards or app loans for everyday spending, borrowing for holidays, parties or luxury items, and taking a new loan to repay an old one. The cost of the borrowing keeps going long after the benefit has gone. A night out paid for with a loan at 10% a month can cost far more than the original bill by the time it is repaid.
Borrowing for an emergency is not automatically bad debt, but it becomes bad when it is expensive, when it happens every month, or when it replaces an emergency fund you could have built.
The key test: cost versus return
The simplest way to judge a loan is to compare what it will cost with what it will bring back. Suppose a tailor borrows 50,000 at 15% a year to buy a second sewing machine that earns an extra 8,000 a month. The machine pays for the loan many times over, so it is good debt. If the same tailor borrows 50,000 at the same rate for a new phone, there is no extra income to cover the repayments, so it is a cost rather than an investment.
Always compare the true cost of a loan, including fees, as an annual rate or a total amount repaid. Our guide on flat rate versus reducing balance loans explains why two loans with the same headline rate can cost very different amounts, and our loan calculator shows the total cost of any loan.
When good debt turns bad
Even good debt can become a burden. A business loan is only good if the business actually earns the expected income; a home loan is only good if you can keep up the repayments when interest rates rise or your income falls. Borrowing too much, choosing a loan with unclear terms or ignoring the risks can turn a sensible plan into a problem. Before borrowing, ask what would happen if your income dropped by a quarter: could you still make the payments?
Questions to ask before you borrow
Will this loan increase my income or lasting wealth? Is the total cost, including fees, clearly stated? Can I afford the repayments even in a bad month? Have I compared other lenders? Could I save for this instead? If you cannot answer these confidently, it is usually better to wait.
Managing the debt you already have
If you already carry expensive debt, focus on paying it down before taking on new borrowing, even for good purposes. Our guide on how to get out of debt on a low income sets out a step-by-step plan, and the digital loan trap explains why short-term app loans are among the most expensive kinds of debt.
Frequently asked questions
What is an example of good debt?
An affordable loan for education, business equipment or a home you can comfortably repay, where the benefit is greater than the cost.
What is an example of bad debt?
Expensive borrowing for everyday spending or things that lose value quickly, such as using app loans or credit cards for consumption.
How do I know if a loan is worth it?
Compare the total cost, including fees, with the income or value the loan will create, and check you can repay even if your income falls.
Sources
This article is general information, not financial advice.