How to Know If You Have Good or Bad Debt

Debt—how can one little word feel so scary? It’s no secret that many Americans are struggling financially right now, and a high debt balance doesn’t help. From student loans to credit cards to mortgages, many consumers struggle to balance repaying not just one source of debt but many. The Federal Reserve Bank of New York’s Center for Microeconomic Data reported that consumer debt rose in 2024, with an increased delinquency rate for auto loans and credit card payments. The point is that if you are struggling with debt, you are far from alone.

If your debt is weighing heavily on your mind, you may need to cut yourself some slack. The first step towards becoming debt-free is self-awareness. Knowing exactly how you got into debt, how much you have, and what realistic changes you need to make to pay it off are all powerful steps to take. Adding unnecessary guilt to your plate won’t do you any good because, truthfully, not all debt is bad. Some debts are considered good. To make debt less frightening, let’s take a look at the difference between good and bad debt, how you can pay off your debt faster, and how to make the most of your good debt.

What is Bad Debt?

Let’s get the icky part out of the way—bad debt. Some forms of debt can be extremely damaging to your financial health. High-interest debt, particularly debt taken on to cover purchases you do not need and cannot afford, is worth paying down ASAP. For example, credit cards are considered to be a bad form of debt. While you may turn to a credit card in a true emergency and be willing to pay the price, if you carry a balance each month because you charge unnecessary purchases you can’t afford to make, you are doing yourself a disservice. Not only are you spending money you truly can’t afford to spend, but you’re increasing the cost of each purchase whenever you fail to pay off your credit card balance in full.

Regardless of whether you’re paying off good or bad debt, the most important thing to do is to not ignore it.

For the same reason, personal loans and borrowing against the equity in your home with a home equity line of credit (HELOC) can damage your financial life if you aren’t careful. While a personal loan or HELOC typically comes with a lower interest rate than a credit card, if you are borrowing for unnecessary purchases, you are wasting money while putting your credit score at risk. Basically, bad debt is any debt that you can’t afford to pay off completely and that won’t advance your own financial progress.

What is Good Debt?

On the flip side, sometimes you need to borrow money to make financial progress. Any debt that can help you make more money or progress in your life is considered good debt. For example, if you need to take out student loans to earn an advanced degree that will increase your earning potential, that is a good source of debt. A mortgage loan is another solid example of good debt—most people can’t afford to buy a house in cash, after all. For many, taking out a mortgage loan is the only way to become a homeowner and escape high rent prices while still investing in their future. A business loan is another form of debt that can lead to financial progress. Even an auto loan can be considered good debt if you make a reasonable car purchase that can help transport you to and from work safely.

How to Make the Most of Good Debt

Most of the time, good debt makes good on your investment—however, even good debt can turn sour if you aren’t careful. This is how you can get more out of the debt you already have:

• Don’t overdo it. Even if you receive a loan offer or credit limit that is greater than you need, don’t overborrow. The more money you borrow, the more you will spend in interest. It’s better not to have the temptation of having extra money on hand to spend. It’s helpful to think of debt as a tool, not a toy.
• Be aggressive with repayment. If you can afford to, consider making an extra payment here or there to pay off your debt faster. The faster you pay off your debt, the less you will spend on interest, which can greatly lower your overall cost of borrowing while still benefiting from the loan in the exact same way.
• Put extra payments towards the principal. Making extra payments only works in your favor if you specify you want the payments to go toward the principal balance of your loan, not the interest. You need to keep making that balance smaller if you want to pay off the actual source of the debt and lower how much interest the lender can charge you.

How to Get Out of Debt Faster

The only way to get out of debt faster is to make extra payments toward your principal balance—which is easier said than done. To speed up your debt repayment journey, here are two steps you can take right now.

Step 1: Adjust Your Budget

First, you need to create a fresh budget. Take a good cold look at your current budget and see where you can start cutting unnecessary expenses or how you can spend less on necessary ones. Make room for additional debt payments in your budget—but as you shift your spending toward debt repayment, remember that these changes don’t have to last forever. Knowing that this period is only temporary can make it easier to buckle down and focus your funds on debt instead of more exciting purchases.

Step 2: Choose a Repayment Method

Once you know how much money you can spend on debt repayment monthly, choose a debt repayment method. Two popular debt repayment methods are the debt snowball and debt avalanche methods. The debt avalanche method will save you the most money on interest. Each month, you will continue to make all of your minimum monthly debt payments (this is a must-do). Then, put any extra money you have available for debt repayment toward the source of debt with the highest interest rate. Once that source of debt is fully paid off, you will put the money you were spending each month on that payment (as well as any extra money you can part with) toward the debt with the next highest interest rate. 

This debt avalanche method will get you out of debt quickest and save you the most money, but some people find the debt snowball method more motivating. With the debt snowball method, you will focus your extra payments on your smallest principal debt. If you have multiple sources of debt, you may find that checking them off your list quickly with the snowball method can help you build momentum and motivation to keep making progress on your debt repayment journey. 

Regardless of whether you’re paying off good or bad debt, the most important thing to do is to not ignore it. Know that getting out of debt is possible—and the debt itself is not nearly as scary as it may seem.

MEET THE AUTHOR

Jacqueline DeMarco

Jacqueline DeMarco is a freelance writer based in Southern California. he has written on a wide range of topics including finance, travel, and wellness for publications such as Coveteur, Girlboss, and Apartment Therapy.

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