How to Tell the Difference Between Good Debt and Bad Debt

Being in debt can feel like an endless struggle—especially if you’re dealing with multiple kinds of debt, like mortgages, student loans, auto loans, and credit card debt. Making payments on all these different types of debt can be tough, and getting ahead without debt relief might seem impossible. To make things worse, you might not even know which debts to start paying off first, or the meaning of “good debt” vs. “bad debt.”

If you’re one of the millions of Americans in debt, you might be surprised to learn that not all debt is bad debt. In fact, some debts can be useful if you want to make more money, buy a home, or improve your finances. Being able to understand good debt vs. bad debt could help you figure out which of your debts you need to worry about first, and which can wait for later.

Not all debt is bad debt. In fact, some debts are useful if you want to make more money, buy a home, or improve your finances.

Good Debt

Any debt that helps you build wealth or create a better financial future can be considered good debt. Good debt may help you find a higher-paying job, own a home rather than rent, and increase your income potential. A few kinds of good debt include the following.

1. Mortgages

Even though it may take 15 to 30 years to pay off, a mortgage could be a good type of debt. Going from being a renter to a homeowner may be smart because the money you put toward your mortgage could go back into your pocket if you decide to sell your home. As long as you have equity, there are many ways to use your home mortgage to better your financial situation. Plus, you won't be subject to the whims of a landlord to raise your monthly housing costs.

2. Student loans

Spending money on your education could help you make more money in the future. Even if it means going into debt, student loans ideally pay for themselves in the long run because of the new career opportunities they could enable. In 2023, median earners aged 22-27 with college degrees made $60,000, while those of the same age with just high school diplomas earned $36,000. However, when considering good debt vs. bad debt, student loans can be problematic if they don’t result in a higher-paying job.

3. Small business loans

Putting money behind your small business idea could be a solid decision because the goal of any small business is to make more money. If you’re a hard worker and have a solid business plan, your small business loan could give you the capital you need to set yourself up for growth and ultimate financial success. Keep in mind, however, that starting any kind of business is inherently risky, so it’s important to properly manage your small business debt.

Good debt isn’t good for everyone in every situation

Other types of good debt also may include certain auto loans (especially if financing a better car allows you to pick up a side gig or drive to a higher-paying job), a mortgage on rental property, or other investments that should increase in value over time. But the good debt vs. bad debt distinction isn’t always so clear, especially if you don’t have the cash to pay it off. Even if you take on good debt, you need to make sure that you’re getting the most value possible.

If you're getting a mortgage, small business loan, or student loan, it’s smart to be frugal. Remember: a good debt is only good if it fits your budget and ultimately makes sense. Always consider what you can afford to spend each month on debt before you take out a new loan—preferably by making a monthly budget. Otherwise, you may end up having to take out a bad debt to cover the cost of a good one.

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Bad Debt

Generally, if you take go into debt to finance anything that will decrease in value over time, that debt can be considered a bad debt. Here are a few different ways to get into bad debt.

1. Credit card debt

One of the most common forms of bad debt is credit card debt. The New York Fed found that in the first quarter of 2025, Americans' credit card debt stood at $1.18 trillion. Though some consumers accumulate credit card debt by buying items they don’t really need, America’s dependence on debt is also linked to stagnant household income and rising costs. Unfortunately, relying on credit cards to pay for essentials can be a slippery slope.

Average credit card APRs hover around 22%, which means credit card debt could end up costing you thousands in interest alone by the time you pay it off—making it one of the worst kinds of bad debt.

2. Personal loans

Personal loans can be used for almost anything—from paying for a vacation or wedding to consolidating your credit card debt. While personal loans often have lower rates than most credit cards, they can be used to purchase items that will decrease in value over time (unlike a mortgage on a house, which should increase in value). That’s why they’re considered a bad debt.

3. Payday loans

Borrowing in the short term could really hurt you over time. Payday loans usually charge you an additional dollar amount for every $100 dollars you need to borrow, ranging from $10-$30. But if you can’t pay within the given amount of time, you could get hit with additional fees. Since payday loans are one of the most expensive types of loans and there are harsh consequences if you can’t pay them back, they are considered bad debt.

Wages have remained stagnant over many years, relative to the cost of living. With no savings and nowhere to turn, many Americans get into bad debt because it’s the only way to get by. If you find yourself in a bad debt situation, there are a few ways to help deal with your money problems.

How to Deal With Bad Debt

The first step in dealing with bad debt is figuring out which of your debts actually could be bad. After you pinpoint the credit card, personal loan, and payday loans that need to be eliminated, come up with a plan to pay it off as fast as you can.

One option is debt consolidation, but if you have a lot of bad debt, a debt consolidation loan may not be your best option. Debt consolidation loans could end up being another form of bad debt if you maintain the spending habits that got you into debt in the first place. Since you have less time to pay off a debt consolidation loan, your payments could be higher than they were before you added the loan.

Another option if you’re struggling with $15,000 or more in bad debt, like credit card debt, is debt settlement. You can do this on your own, but professional debt negotiators have more experience and leverage and may be able to get larger debt settlements than you could as an individual working alone.

Could You Use Some Help With Your Finances?

Understanding good debt vs. bad debt, how interest rates work, and other aspects of consumer debt will help you improve your financial well-being. But if you’re struggling with debt, it might be time to take action.

Freedom Debt Relief is here to help you understand your debt-relief options, including our debt settlement program. Our Certified Debt Consultants can help you get a handle on your situation and minimize your bad debt. Find out if you qualify right now.