The basic framework
The “good debt versus bad debt” distinction provides a way to evaluate borrowing decisions beyond simply “debt is bad.” The framework categorizes debt based on what the borrowed money finances and whether that use tends to improve or worsen long-term financial position.
Good debt describes borrowing that finances something expected to increase in value or generate income. The canonical examples are mortgages (financing appreciating real estate), student loans (financing education that increases earning potential), and business loans (financing ventures expected to generate returns exceeding borrowing costs).
Bad debt describes borrowing for consumption, particularly depreciating purchases financed at high interest rates. Credit card debt for everyday spending, car loans on expensive vehicles, and personal loans for vacations exemplify this category.
The framework isn’t about morality. It’s about expected outcomes. Borrowing $30,000 for education that enables a $20,000 salary increase has different financial mathematics than borrowing $30,000 for a car that will be worth $15,000 in three years.
The investment logic
Good debt follows investment logic: the return on the borrowed money exceeds the cost of borrowing. A mortgage at 7% on a property appreciating at 4% annually while also eliminating rent payments can produce positive returns. A business loan at 10% for equipment that generates 25% returns creates value despite the debt.
The comparison isn’t always direct. Student loans don’t produce investment returns in the traditional sense, but they enable career paths with higher lifetime earnings. The calculation compares the present value of additional earnings against the total cost of the loans including interest.
This logic has limits. Expected returns aren’t guaranteed. The 2008 housing crisis demonstrated that real estate can depreciate sharply. Many college graduates discovered their degrees didn’t produce the salary increases they’d anticipated. Business ventures fail.
Good debt as a category means “borrowing for purposes that historically and logically tend to produce positive returns.” It doesn’t mean “borrowing that will definitely work out.”
Why mortgages are typically classified as good debt
Mortgage debt finances an appreciating asset (historically, over long periods) while replacing a necessary expense (housing). The homeowner would be paying for housing regardless; the mortgage converts that payment from rent to equity building.
Several factors contribute to the “good debt” classification:
Historically appreciating asset: U.S. home prices have increased at roughly 3-5% annually over long periods, though with significant regional and temporal variation. Unlike a car, which loses value immediately, a house tends to be worth more at sale than at purchase.
Leveraged returns: A $50,000 down payment on a $250,000 house means 20% equity controls 100% of appreciation. If the house appreciates $25,000 (10%), that’s a 50% return on the $50,000 invested. Leverage amplifies returns (and losses).
Tax advantages: Mortgage interest is deductible for many homeowners, reducing the effective interest rate. Property taxes are also partially deductible, though capped at $10,000 combined with state and local income taxes.
Forced savings mechanism: Each mortgage payment includes principal reduction, building equity automatically. Renters must consciously save; homeowners build equity through payments they’d make for housing anyway.
Inflation hedge: Fixed-rate mortgages lock in payment amounts while incomes and rents typically increase with inflation. A $2,000 payment feels larger in 2025 than it will in 2045.
The classification isn’t absolute. A mortgage at an inflated price during a bubble, in a declining market, with an adjustable rate that increases significantly, or on a property the owner can’t actually afford transforms good debt into a financial crisis.
Why student loans are typically classified as good debt
Student loan debt finances increased earning potential. The logic: education enables career paths that produce higher lifetime earnings than would be accessible without the credential.
The data supports this on average. College graduates earn significantly more than high school graduates over their careers, and the gap has widened over decades. The unemployment rate for college graduates is consistently lower than for those without degrees.
However, averages obscure enormous variation:
Field of study matters: Engineering, computer science, nursing, and accounting graduates typically earn returns that justify substantial debt. Art history, philosophy, and general studies graduates often find the salary premium doesn’t cover the borrowing cost. This isn’t a judgment on the value of those fields; it’s a statement about labor market economics.
Institution matters: A degree from a selective university may open doors that justify higher tuition. The same degree from an unknown for-profit institution may not. Employer perception and alumni networks affect outcomes.
Completion matters: The worst outcome is borrowing for education and not finishing. The debt remains but the credential and earning premium don’t materialize. Roughly 40% of students who start bachelor’s degrees don’t complete them within six years.
Amount matters: $30,000 in student debt for a degree leading to $60,000 starting salary has very different mathematics than $150,000 in debt for a degree leading to $45,000 starting salary.
The “good debt” classification applies when: debt amounts are reasonable relative to expected starting salaries (a common guideline is total debt shouldn’t exceed first year’s expected salary), the field of study has strong employment outcomes, and the student is likely to complete the program.
Why credit card debt is typically classified as bad debt
Credit card debt usually finances consumption rather than investment, carries high interest rates (typically 18-28% APR), and attaches to purchases that depreciate or have no residual value.
A $5,000 vacation financed on credit cards at 22% APR, paid off over three years, costs roughly $7,000 total. The vacation provided value, but that value is gone. The payments continue for years after the experience ended.
Credit card interest rates exceed almost any reasonable investment return. Paying 22% interest while potentially earning 8-10% in the stock market produces guaranteed negative spread. Every dollar of credit card debt effectively loses 12-14% annually compared to the alternative of investing that money.
The consumption nature of most credit card purchases means the borrowed money finances depreciating or consumable items: clothing, meals, electronics, entertainment. These have value, but not financial value that compounds.
Exceptions exist. A credit card balance from an unexpected emergency (medical bill, car repair necessary to keep a job) might be unavoidable despite being “bad debt” by the framework. Using a 0% promotional rate strategically, where the money could be invested during the promotional period and repaid before interest accrues, technically profits from the debt.
Why car loans occupy a middle ground
Auto loans finance depreciating assets at moderate interest rates, creating a classification challenge. A new car loses 20-30% of its value in the first year and continues depreciating throughout the loan term.
However, cars serve practical purposes. Transportation to work enables income. The car has functional value even as it loses financial value.
The “goodness” or “badness” of auto debt depends heavily on specifics:
Necessity versus luxury: A $15,000 used car to enable a $50,000 job has different calculus than a $60,000 luxury vehicle for someone who could accomplish the same transportation in a $25,000 car.
Interest rate: A 3% auto loan has fundamentally different costs than a 15% loan from a subprime lender. The rate changes total cost dramatically.
Loan term: A 36-month loan builds equity faster than a 72-month loan. Longer terms can result in being “underwater” (owing more than the car is worth) for years.
Alternatives: In cities with reliable public transit, car ownership is a choice rather than a necessity. In car-dependent areas, some level of transportation spending is unavoidable.
When “good debt” turns bad
The categories aren’t permanent. Good debt can become bad debt through:
Overpaying: A mortgage on an overpriced house, student loans for an overpriced education, or a business loan for an overvalued acquisition starts as good debt but may not produce positive returns.
Rate changes: Variable-rate debt can become unaffordable if rates rise substantially. An adjustable-rate mortgage that was affordable at 4% might not be at 8%.
Income disruption: Debt sized for a higher income becomes crushing when income drops. A manageable mortgage payment during employment can force foreclosure during extended unemployment.
Overleveraging: Individually reasonable debts can be collectively overwhelming. A mortgage, car loans, and student loans that each pass the “good debt” test might together consume too much income.
When “bad debt” might be acceptable
The framework describes tendencies, not absolute rules. Credit card debt might be the least-bad option in certain situations:
True emergencies: An emergency room visit without insurance or a car repair that prevents job loss might warrant credit card debt if no emergency fund exists. The alternative (no medical care, no transportation to work) produces worse outcomes.
Strategic short-term use: Financing a necessary expense at 0% promotional APR and paying it off before interest accrues isn’t really bad debt since no interest cost exists.
Business expenses between invoices: Self-employed individuals sometimes use credit cards to smooth cash flow between payment receipt and expense timing. If paid in full when client payments arrive, no interest accrues.
How to evaluate a borrowing decision
Rather than asking “is this good debt or bad debt,” a more useful evaluation considers:
What does this borrowing finance? An appreciating asset, an income-increasing investment, a necessary expense, or pure consumption?
What is the interest rate? How does it compare to returns the money might otherwise generate?
What is the total cost? Principal plus all interest over the loan term, not just the monthly payment.
What happens if circumstances change? Can payments continue through income disruption? What’s the exit strategy if the investment doesn’t perform?
Are there alternatives? Could the goal be accomplished without borrowing, with less borrowing, or with cheaper borrowing?
These questions produce more nuanced answers than categorical labels. A “good debt” category doesn’t make a specific mortgage wise. A “bad debt” category doesn’t make a specific credit card balance catastrophic.
The limit of the framework
The good/bad framework simplifies complex trade-offs into categories. It provides useful shorthand but doesn’t replace analysis.
Real financial decisions involve uncertainty, personal preferences, and circumstances the framework doesn’t capture. Someone might reasonably choose “bad debt” with full understanding: financing a wedding, taking a trip with aging parents, or buying a car that brings genuine joy despite being more expensive than necessary.
The framework’s value is in highlighting what borrowing tends to produce. It’s a starting point for thinking about debt, not a rule that eliminates the need for judgment.