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Is Some Debt Worse Than Others?

What makes debt good or bad? Learn about different types of debt, and find tips for managing and paying off debt responsibly.

Couple in living room with laptop and paperwork.

Key Takeaways

Good debt is low-interest debt that improves your quality of living or net worth. But even good debt can get out of hand.

When choosing which debt or loans to pay off first, consider the interest rate and balance owed before you make a decision.

Debt doesn’t have to keep you from investing, if long-term returns could potentially outpace your debt’s interest rate.

You may have heard the term “no debt is good debt,” but is that true?

Most of us don’t have the cash to make large purchases, and some debt is inevitable for many. That’s why some people make a distinction between good debt versus bad debt.

Learn the difference between good debt versus bad debt, what debt to pay off first and why you shouldn’t neglect other financial goals during your debt repayment journey.

What Is Good Debt?

Generally, good debt is low-interest debt that ultimately improves your quality of living or net worth. Examples of good debt include:

Student loans are an investment in your future, enabling higher earning potential. Student loans generally have lower interest than other forms of debt.

Mortgages help buyers become homeowners, potentially increasing their net worth through property ownership.

Car loans may be necessary for many people for their day-to-day living. While a car’s value depreciates, a car can be a tool to ensure steady employment.

While the above examples are generally considered good debt, remember that having too much debt, even “good debt,” can be problematic. Buying an expensive home or car that you can’t afford or having a student loan payment that significantly impacts your discretionary income can be just as bad as “bad debt.”

What Is Bad Debt?

Bad debt is generally high-interest or variable interest rate debt and oftentimes tied to a “want” rather than a “need.” Sometimes, bad debt starts as good debt, but due to overspending, it gets out of hand.

Bad debt could be tied to discretionary or irresponsible spending—making purchases that depreciate, don’t help you earn more or don’t improve your quality of life in the long run.

Bad debt typically includes:

Credit cards with high interest rates or credit card bills large enough that you can’t afford to pay them off in full.

High-interest personal loans that aren’t used for an emergency or with a goal in mind.

Payday loans can come with predatory practices and sky-high interest rates. The short-term loans can eat into paycheck after paycheck.

It’s important to understand the reasons for taking on debt and working to keep it under control. Taking on any debt and letting it get out of hand can impact long-term savings goals.

What Do I Pay Down First?

Deciding what debt to pay down first hinges on a few factors:

Interest rate is often the most significant determinant of what debt to pay down first. Paying off high-interest debt first could mean savings in the long run because you’ll accrue less interest on a loan or debt.

Balance owed is also important to keep in mind. For some, eliminating the lowest-balance debt first can mean a quick win. Then you can take the money you were putting toward that payment and add it to another account or loan payment. But others may prefer chipping away at high-balance debt first.

Peace of mind can help make your decision. If you have only good debt, you may be unsure of what debt to tackle more aggressively. At the end of the day, consider what debt keeps you up most at night, and that may be the one to prioritize paying down.

Whether you’re paying down debt alone or as a couple, take the time to look at the big picture to get a clearer understanding of which to prioritize.

Considering taking on a mortgage on a new house—or helping a family member with a down payment?

Learn more about the rules for gifting money to family.

Don’t Let Debt Keep You From Investing

Carrying debt of any kind can feel like a burden. Some debt may be unavoidable, especially when it comes to improving quality of life through owning property or getting an education.

Remember, with good debt, when the interest rate is low enough, you may be better off paying the minimum right now and putting additional funds toward investment and retirement. Consider that since the beginning of the stock market over 220 years ago, stocks have consistently returned an average of 6.5 to 7.0 percent per year after inflation.1 If your “good debt” has an interest rate below those returns, it may be beneficial to invest some cash rather than rushing to pay down low-interest debt.

Trying to Pay Down Debt and Invest?

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“Markets will be markets: An analysis of long-term returns from the S&P 500,” McKinsey Insights. McKinsey & Company, August 4, 2022.

This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.