Good Debt, Bad Debt

“Good” debt, loosely, is debt that either buys something likely to hold or grow in value, or increases what you're capable of earning. A mortgage on a home in a stable market, a reasonable student loan for a degree that measurably raises your earning potential, and a small business loan backed by a real plan all fit this shape — the debt is a tool for building something, not just a way to spend before you've earned.

Run the numbers on a concrete case. A $40,000 nursing degree, financed at 6% over ten years, costs roughly $444 a month and about $13,300 in total interest. If that degree moves your income from $32,000 a year to $58,000, the $26,000 raise covers a full year of loan payments — about $5,300 — in roughly the first three months of every year, before tax, for as long as you hold the job. The debt bought a permanently higher earning line, not a thing that sits on a shelf losing value.

A mortgage works on the same logic from the asset side rather than the income side. A $320,000 home loan at 6.5% fixed over 30 years costs about $2,022 a month. Home prices don't rise every year, but historically they've tracked somewhere near 3%–4% annually over long stretches — meaning a meaningful share of that monthly payment is, slowly, buying an asset rather than renting one.

“Bad” debt finances something that loses value the moment you buy it, or worse, something already spent by the time the bill arrives — a night out, a vacation, a purchase with nothing left to show for it except the balance.

Put a number on it. A new car bought with a $30,000 loan commonly loses around 20% of its value in its first year and roughly 50% within five years — meaning the loan balance can outpace the car's resale value for years at a stretch. A $3,000 vacation charged to a card at 22% APR and paid off at $100 a month takes 44 months — three and a half years — to clear and adds about $1,395 in interest, for a trip that ended the week it started. Neither loan bought anything that's still there.

Retire the slogan and you're left with a real test, and it has four parts. None of them is “what was the money spent on,” which is the question the good/bad framing tricks people into asking first.

1. 1

   The rate

   What APR are you actually paying, compared to what that money could otherwise earn, or to what inflation is running? A 6% mortgage and a 24% credit card are not the same category of decision just because both are called debt.

2. 2

   The term

   How long are you locked into this payment, and does that length match how long the thing you bought will still have value or use? A five-year loan on a car you'll trade in after three years means still owing money on something you no longer have.

3. 3

   Does the thing bought hold or lose value

   A home historically holds or grows. A car depreciates from day one. A vacation is already spent by the time the statement arrives. This is the closest thing to the old 'good versus bad' split, but it's one input, not the whole answer.

4. 4

   Does the payment survive a lost paycheck

   If your income stopped for three months tomorrow, could this payment still be made from savings or a lower income? A loan with an unaffordable payment is fragile debt no matter how good the rate looks on paper.

A car loan for reliable transportation to a job you couldn't otherwise reach is closer to good debt. The same car loan, at a punishing rate, for a car well beyond what the budget in this track's earlier chapters would support, tips toward bad — the category isn't fixed to the purpose, it moves with the rate, the term, and whether the payment actually fits.

Compare two versions of the same $22,000 car loan directly. At 6% over five years, the payment is about $424 a month and total interest comes to roughly $3,458. At 18% over seven years — the kind of offer a buy-here-pay-here lot might extend to someone with thin credit — the payment only rises to about $462 a month, a $38 difference that's easy to wave off. But total interest climbs to roughly $16,841, nearly five times as much, and the car is worth less than what's still owed for most of that stretch. Same purpose, similar monthly payment, radically different debt.