Good Debt V. Bad Debt

The Federal Reserve Bank of New York reported U.S. household debt surpassed $14.56 trillion in the fourth quarter of 2020, a $414 billion surge from the same period in 2019. Credit-monitoring giant Experian put the average U.S. household debt at the end of 2020 at $92,727, a 10-year high. 25% of Americans felt worried or stressed because of their debt in April 2021, but should they be?

There are differences between the types of debt people hold. Some deserve all the worry they induce, while others should let you dream of a more financially secure future.

Good debt should ideally be in low amounts, have low interest, help achieve financial goals, and have potential tax advantages, compared with bad debt which offer the opposite. Here are some examples of common types of debt being used in a good or a bad way:

Home Mortgages

Good: Home Mortgages are good when they have low interest rates. Since this type of debt usually spans over the course of 15-30 years, having a lower interest rate will save thousands of dollars over time. Taking out a loan for a home is also good since it helps build equity and can also create opportunities to live in a better neighborhood or move closer to work.

Bad: Home mortgages are bad when interest rates are high and/or the payment gives you a debt to income ratio higher than about 40%. The key is not to be strapped down by a mortgage, as it is the largest monthly expense for most people.

Home Equity Lines of Credit (HELOC)

Good: HELOCs can be positive when they are used for home improvements, since it increases the value of the home and have potential tax advantages. 

Bad: HELOCs aren’t so great when the money is used to buy non-tax deductible items like a new car, gifts, or other depreciating assets. Bad HELOCs can also increase your interest rate and set back the timeline to pay back a loan. 

Student Loans

Good: Student loans make sense if they are used to get a well-paying job. According to the Bureau of Labor Statistics, full-time workers over 25 with only a high-school diploma had a median weekly income of $789, whereas their counterparts with a college degree earned a median weekly income of $1,416, as of mid 2020. Student loan debt may be the only way to achieve higher incomes especially in high earning fields like engineering, law and medical.

Bad: 

Student loans are not the best choice if the salary earned after getting a degree makes it nearly impossible to pay it off. CNBC reported on a survey of 1,000 Millennials in their 30’s, and 52% said their loans weren’t worth it because of the lack of higher paying jobs offered to them after graduation. 

Credit Cards

Good: Credit cards, contrary to popular belief, may be beneficial. Credit cards work best when they have great rewards, 0% or low interest rates, and are paid off every month. Credit card rewards can make gift shopping easier or help pay for a vacation flight

Bad: Credit cards can lead down a slippery slope when interest rates are higher than 15% and balances are not paid off monthly. Unless absolutely necessary, making purchases that aren’t affordable, unless paid by credit, such as clothing and accessories, are bad credit card debt. 

Automotive Loans

Good: Taking out a loan to buy a car is advantageous when it is necessary to get to work or do essential life activities. The best types of automotive loans are ones with low interest rates (<4%), a term of 4 years or less, an affordable monthly payment. All this considered, a car is not affordable if a minimum of a 20% down payment cannot be made. 

Bad: Automotive loans get bad when interest rates are high, payments are spread out too long, and the car is not affordable given current monthly expenses. Car values drop immediately around 20% when they drive off the lot, so buying a brand new luxury car is commonly considered bad debt. 

Personal Loans 

Good: Personal loans are favorable when consolidating other debts such as credit cards. They can offer lower interest rates and make payments more manageable as all debts are in one place.  

Bad: Personal loans are poor choices when used to fund a vacation or buy unnecessary clothing or accessories. 

As of May 2020, Americans have driven down their credit card balances by 14% since the same time in 2019, which Experian calls “historic”. The debt Americans have added have been home mortgages, student loans and automobiles, which, for the most part, demonstrates a positive trend. The emotions Americans are facing today about large amounts of household debt may not be as worrisome or stressful as long as good debt habits continue. 

Sources: Charles Schwab, Equifax, Nerd Wallet, WSJ, Debt.org,

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