When I was weighing the decision of going back to school, debt was a very big part of the discussion. I was hesitant to take on a lot of debt. Business school is very expensive and I was fortunate to graduate from undergrad with just a small amount of debt. Was it wise to take on so much debt for another degree?
When I voiced these concerns to friends and family members I was quickly reassured that the debt was ok. This was, after all, good debt.
At the time, I didn’t question it. I jumped into grad school and loaded up on all the debt I was offered. By the time I graduated, with six figures of “good debt” I realized that I wasn’t quite so sure if I understood the real difference between good and bad debt.
What’s the Difference Between Good and Bad Debt?
Debt is money that you owe. People often use debt to pay for things that they don’t have the cash to pay for, turning instead to borrowing.
All debt, however, isn’t seen as equal. You’ve likely heard debt broken down into two categories: good and bad.
When a debt is referred to as being a good debt, it is generally been used to buy or invest in something that will appreciate in value. Shannah Compton Game, CFP and host of Millennial Money Podcast describes good debt as, “debt that has a relatively low-interest rate, usually under 7%, and also has the chance to increase your net worth.”
Federal student loans are an example of what people usually see as good debt. They often come with a low-interest rate and are an investment someone makes in themselves with the hope of making more money or advancing their career in the future.
Other examples of good debt can include a home mortgage or a small business loan.
Bad debt consists of other debt that doesn’t fit into the “good debt” category. When debt comes with a high interest rate or isn’t used to buy something that will appreciate in value and add to your net worth, it’s likely going to be considered bad debt.
A classic example of bad debt is credit card debt. According to CreditCards.com Weekly Credit Card Rate Report, the average APR on a credit card is over 17% for the week of October 2, 2019. The high, and often compounding, interest rate puts credit card debt into the bad debt category.
Can Good Debt Become Bad?
Even with a low interest rate, good debt isn’t always good in every situation.
“Debt, whether classified as good or bad debt, must always be weighed against your budget and what you can afford. Good debt can quickly turn into bad debt if you can’t afford to make the payments,” says Game.
Before you make a decision about whether to take on debt, it’s a good idea to dig deeper than simply categorizing debt as good or bad — a trap I fell into as I was repeatedly assured my student loan debt was good debt.
Consider what you can afford, what interest rate you’ll qualify for, and whether what you’re spending on is an investment. Once you do that you’ll be better positioned to make the right decision about debt for you.
Disclaimer: The opinions expressed by the interview subject are not necessarily those of Earnest.