Highlights:
- Some types of debt can be advantageous if managed responsibly
- "Bad debt" can be any debt you're unable to repay
- Learn steps you can take to avoid bad debt
Did you know there actually can be such a thing as good debt? Many people mistakenly think all debt is bad, but there are certain types of debt that can be advantageous when it comes to your credit.
So, what is “good debt"?
Speaking generally, debt that you're able to repay responsibly based on the loan agreement can be "good debt," as a favorable payment history (and showing you can responsibly handle a mix of different types of debt) may be reflected in credit scores. In addition, "good" debt can be a loan used to finance something that will offer a good return on the investment. Examples of good debt may include:
Your mortgage.You borrow money to pay for a home in hopes that by the time your mortgage is paid off, your home will be worth more. In some cases, you can deduct the interest on mortgage debt on your taxes. Home equity loans and home equity lines of credit — which are a type of loan in which a borrower uses his or her home as collateral– may also be considered a form of good debt. The interest payments on these are tax-deductible as long as you use the loan for its intended purpose: to buy, build or renovate the home used as collateral.
Student loans can be another example of “good debt.” Somestudent loans have lower interest rates compared to other loan types, and the interest may also be tax-deductible. You’re financing an education, which can lead to career opportunities and potentially increasing income. However, a student loan becomes a bad debt if the loan is not paid back responsibly or within the terms agreed upon. It can also become burdensome if you have so much student loan debt that it takes years (and more interest payments) to repay.
Auto loans can be good or bad debt. Someauto loans may carry a high interest rate, depending on factors including your credit scores and the type and amount of the loan. However, an auto loan can also be good debt, as owning a car can put you in a better position to get or keep a job, which results in earning potential.
What is “bad debt”?
Simply put, “bad debt” is debt that you are unable to repay. In addition, it couldbe a debt used to finance something that doesn’t provide a return for the investment. Debt could also be considered "bad" when it negatively impacts credit scores -- when you carry a lot of debt or when you're using much of the credit available to you (a high debt to credit ratio).
Credit cards, particularly cards with a high interest rate, are a typical example. If you can’t pay your credit cards in full every month, interest payments can prolong the debt.
High-interest loans -- which could include payday loans or unsecured personal loans -- can be considered bad debt, as the high interest payments can be difficult for the borrower to pay back, often putting them in a worse financial situation.
What to Do to Avoid Bad Debt
If you’re making a purchase that increases your debt,ask yourself how this purchase will benefit you – not just today, but long term. Is the debt you’ll incur going to provide you a lasting benefit, or is it something that will satisfy an immediate desire that you can’t afford?
It’s also a good idea to have a rainy-day or emergency fund for unexpected expenses, so you won’t have to use credit cards to pay them.
Try to keep your debt to credit ratio (the ratio of how much you owe compared to the total amount of credit available to you) as low as possible to avoid being viewed as a risky borrower by lenders. Focus on paying the debt you have and restrict new purchases.
Lastly, it’s always important to pay your bills on time, every time.
FAQs
Debt can be good or bad—and part of that depends on how it's used. Generally, debt used to help build wealth or improve a person's financial situation is considered good debt. Generally, financial obligations that are unaffordable or don't offer long-term benefits might be considered bad debt.
What is considered bad credit debt? ›
High-interest loans -- which could include payday loans or unsecured personal loans -- can be considered bad debt, as the high interest payments can be difficult for the borrower to pay back, often putting them in a worse financial situation.
Is a car loan good or bad debt? ›
Generally speaking, cars purchased with a large down payment and with a short-term car loan are considered to be good debt. That's because large down payments usually mean lower interest rates. Further, a shorter loan term means you'll pay less in interest over the life of the loan.
What is the difference between good credit and bad credit? ›
What does it mean to have bad credit? Under the FICO scoring model, people with poor credit have scores between 300 and 579. Get your score between 580 and 669 and you'll move into the fair credit range; bump your score past 670, and you'll achieve good credit.
Is a mortgage a good or bad debt? ›
Mortgages are seen as “good debt” by creditors. Since the mortgage debt is secured by the value of your house, lenders see your ability to maintain mortgage payments as a sign of responsible credit use. They also see home ownership, even partial ownership, as a sign of financial stability.
What qualifies as bad debt? ›
Simply put, a bad debt is a type of expense that occurs after repayment by a customer (when credit has been extended) is no longer considered to be collectable. In other words, bad debt is an irrecoverable receivable.
What is an example of a good debt? ›
Examples of good debt are taking out a mortgage, buying things that save you time and money, buying essential items, investing in yourself by borrowing for more education or to consolidate debt. Each may put you in a hole initially, but you'll be better off in the long run for having borrowed the money.
What is the average bad debt write off? ›
The ratio measures the money a company loses on its overall sales due to customer(s) not paying their dues. The average bad debt to sales value in 2022 was 0.16%. The companies with the best ratio (best performers) reported a value of 0.02% or lower.
Is a 900 credit score possible? ›
Highlights: While older models of credit scores used to go as high as 900, you can no longer achieve a 900 credit score. The highest score you can receive today is 850. Anything above 800 is considered an excellent credit score.
Which is worse credit card debt or car loan? ›
In general, it's best to pay off credit card debt first, then loan debt, since credit cards often have the highest interest rates. When you prioritize paying off credit card debt, you'll not only save money on interest, but you'll potentially improve your credit too.
Like credit cards, a line of credit is considered revolving debt and treated similarly when generating your credit score—if you make your payments in full and on time, it will reflect positively in your credit score.
Is it good to pay off bad debt? ›
Generally speaking, the damage to your credit scores that may result from paying off debt is unlikely to be permanent. It's always a good idea to keep up with your debt payments and repay what you owe. The long-term benefits to your credit scores and the ability to live debt-free are well worth it.
How to get an 800 credit score? ›
Making on-time payments to creditors, keeping your credit utilization low, having a long credit history, maintaining a good mix of credit types, and occasionally applying for new credit lines are the factors that can get you into the 800 credit score club.
What credit score is no credit? ›
Fortunately, no one's credit score can equal zero – the range for FICO scores is 300-850 – and even people with poor or bad credit have a credit score of at least 300. A “no credit score” means there is insufficient information for a credit score calculator to compute a score.
Is it better to have no credit cards? ›
It's completely acceptable to avoid getting a credit card. Consumers can pay entirely with cash, check or debit card and still build a positive credit history through other types of loans.
What types of debt is good? ›
Examples of good debt are taking out a mortgage, buying things that save you time and money, buying essential items, investing in yourself by borrowing for more education or to consolidate debt. Each may put you in a hole initially, but you'll be better off in the long run for having borrowed the money.
Is bad debt a gain or loss? ›
Under the direct write-off method, bad debt expense serves as a direct loss from uncollectibles, which ultimately goes against revenues, lowering your net income.
What is good and bad business debt? ›
Good debt drives your business forward, helping you to grow faster, while bad debt can constrain growth or even threaten the survival of your company. A smart approach to good and bad debt means reviewing your debts and prioritising repayments.
What is the difference between bad debt? ›
Thus, a bad debt is a specifically-identified account receivable that will not be paid and so should be written off at once, while a doubtful debt is one that may become a bad debt in the future and for which it may be necessary to create an allowance for doubtful accounts.
