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.
How do you differentiate good and bad credit? ›
FICO credit scores
- Poor: 300-579.
- Fair: 580-669.
- Good: 670-739.
- Very Good: 740-799.
- Exceptional: 800-850.
FICO score ranges
- Below 580: poor.
- 580 to 669: fair.
- 670 to 739: good.
- 740 to 799: very good.
- 800 and above: exceptional.
The bottom line: Credit card debt is considered "bad" debt because of its high interest rates and low minimum payments, and the fact that it isn't used to buy appreciating assets. Use your credit cards for the rewards and other benefits, but pay the balance in full each month.
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.
Which is an example of 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.
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.
What is a 580 FICO score considered? ›
Your score falls within the range of scores, from 580 to 669, considered Fair. A 580 FICO® Score is below the average credit score. Some lenders see consumers with scores in the Fair range as having unfavorable credit, and may decline their credit applications.
Can you be poor and have good credit? ›
Despite what many people think, your credit score is completely independent of your income. People with $20,000 salaries can have good credit scores, just like those with $200,000 incomes can have poor credit scores. Credit scores only look at one thing—your credit history.
How rare is a 700 credit score? ›
Credit score distribution: How rare is an exceptional 800 to 850 score?
| FICO® Score range | Percent within range |
|---|
| 650-699 | 12% |
| 700-749 | 17% |
| 750-799 | 24% |
| 800-850 | 23% |
4 more rowsMay 31, 2023
Examining the C's of Credit
For example, when it comes to actually applying for credit, the “three C's” of credit – capital, capacity, and character – are crucial.
How to get 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 is the 15-3 rule? ›
When you have a credit card, most people usually make one payment each month, when their statement is due. With the 15/3 credit card rule, you instead make two payments. The first payment comes 15 days before the statement's due date, and you make the second payment three days before your credit card due date.
How to raise your credit score 200 points in 30 days? ›
How to Raise your Credit Score by 200 Points in 30 Days?
- Be a Responsible Payer. ...
- Limit your Loan and Credit Card Applications. ...
- Lower your Credit Utilisation Rate. ...
- Raise Dispute for Inaccuracies in your Credit Report. ...
- Do not Close Old Accounts.
It's possible that you could see your credit scores drop after fulfilling your payment obligations on a loan or credit card debt. Paying off debt might lower your credit scores if removing the debt affects certain factors like your credit mix, the length of your credit history or your credit utilization ratio.
What is a bad debt example? ›
For example, if a company sells its products on credit to a customer who fails to pay according to the terms agreed upon, the sale will be considered a bad debt after all efforts to recover the amount owed have been exhausted.
What are the characteristics of good and bad debt? ›
Good debt can increase your net worth and build in value over time. Bad debt is money spent on items that lose their value. Balancing good and bad debt is important to your financial wellbeing.
How much debt is considered bad debt? ›
Key takeaways
Debt-to-income ratio is your monthly debt obligations compared to your gross monthly income (before taxes), expressed as a percentage. A good debt-to-income ratio is less than or equal to 36%. Any debt-to-income ratio above 43% is considered to be too much debt.
What is considered healthy debt? ›
35% or less: Looking Good - Relative to your income, your debt is at a manageable level. You most likely have money left over for saving or spending after you've paid your bills. Lenders generally view a lower DTI as favorable.
