A guide to borrowing wisely

Debt often gets a bad reputation, but not all debt is created equal. Some types of borrowing can help you build wealth, achieve long-term goals, or increase your earning potential. Other types, though, can strain your finances and make it harder to get ahead.

Understanding the distinction between good debt vs. bad debt is crucial for borrowing strategically. Understanding how each works and how to manage them responsibly can help you make more informed financial decisions and stay on track toward your goals.

Good debt is borrowing that helps you build long-term value or improve your financial position. It’s typically tied to an asset or opportunity that can grow in worth or generate income over time. When used strategically and managed wisely, this type of debt can be an investment in your future.

Here are a few common examples of good debt:

• Student loans: Education can be expensive, but borrowing to earn a degree or credential that increases your earning potential can pay off in the long run. Federal student loans, in particular, offer fixed interest rates and flexible repayment plans, making them a manageable form of good debt when used for marketable degrees.

• Mortgages: Home loans let you purchase a property that can appreciate in value and build equity as you make payments. Over time, your home becomes an asset that you can live in, rent out, or eventually sell for profit.

• Auto loans: Vehicles depreciate over time, but a well-managed auto loan with a low interest rate and a reasonable repayment term can still qualify as good debt when it’s tied to reliable transportation for work or family.

• Home equity loans and lines of credit (HELOCs): These allow you to borrow against your home’s equity for large expenses, such as renovations or debt consolidation. When used responsibly, a home equity loan or HELOC can fund projects that increase your property’s value or improve your financial stability.

• Business loans: For entrepreneurs, borrowing to start or expand a business can help generate income and long-term value. The key is to borrow within reason, with a clear plan for profitability.

Of course, even good debt has limits. Taking out more than you can afford, missing payments, or relying on credit without a plan can quickly turn an opportunity into a financial setback. Good debt only stays “good” when it’s used intentionally and managed responsibly.

Bad debt typically refers to borrowing that doesn’t add long-term value or improve your financial health. It’s often tied to purchases that lose value quickly or carry high interest rates, making them difficult to repay without strain. While some types of “bad debt” can be manageable in moderation, they rarely provide a return on investment.

Here are some common examples:

• Credit card debt: Using credit cards for everyday spending can be convenient, but carrying a balance month to month can quickly become costly. With average interest rates exceeding 20%, debt from nonessential items such as clothing, travel, or dining can balloon if not paid off quickly.

• Payday loans: These short-term loans are among the most expensive forms of credit, with fees and interest that can translate to an average annual percentage rate (APRs) of just under 400%. Payday loans are easy to get but extremely hard to escape once you fall behind.

• Personal loans for discretionary purchases: Borrowing a personal loan to fund vacations, luxury items, or other optional expenses can strain your budget and add unnecessary financial pressure.

• Long-term or high-interest auto loans: While car loans can be considered good when reasonable, stretching a loan to six or seven years for a rapidly depreciating vehicle can result in negative equity, which is when you owe more than the car is worth. Meanwhile, high-interest auto loans can keep you financially trapped.

Bad debt doesn’t mean you’ve failed financially — it simply means the money you borrowed isn’t working for you. If you’re carrying high-interest or nonproductive debt, create a plan to pay it down and avoid similar borrowing in the future.

At first glance, all debt can look the same; it’s money you owe to a lender, after all. But the real distinction between good and bad debt lies in purpose, payoff, and cost. Understanding these differences can help you make smarter borrowing decisions and avoid financial pitfalls.

Here’s how to tell them apart:

• Purpose: Good debt helps you build wealth or improve your financial position over time — like buying a home, earning a degree, or starting a business. Bad debt, on the other hand, usually funds short-term wants or depreciating assets, such as credit card spending or high-interest personal loans for nonessential purchases.

• Payoff potential: If the debt helps you generate income, increase your net worth, or add lasting value, it’s likely on the good side of the spectrum. Borrowing for things that don’t hold value or create future opportunities generally falls into the bad category.

• Cost: Interest rates and repayment terms matter. A low, fixed-rate auto loan can be manageable and productive, while a 25% credit card balance can quickly become unmanageable.

• Tax benefits: Some good debts, including mortgages, student loans, or certain business loans. may offer tax deductions or other advantages. Bad debts rarely come with such perks.

• Repayment flexibility: Debts with predictable payments, long repayment terms, or options for deferment are easier to manage. High-interest or variable-rate debts are more likely to create instability and stress.

If you’re unsure which category a debt falls into, ask yourself: Will this purchase help me build future wealth or stability, or just provide short-term satisfaction? That quick gut check can often reveal whether the debt will move you forward or hold you back.

Even good debt can turn sour if it’s not managed carefully. The goal isn’t just to borrow; it’s to borrow strategically, with a clear plan for repayment and a long-term payoff that justifies the cost.

Here’s how to make the most of good debt:

• Borrow only what you need: Just because you qualify for a large loan doesn’t mean you should take it. Stick to the amount required to meet your goal.

• Shop for the best terms: Compare lenders to find the lowest interest rates, flexible repayment options, and minimal fees. Even a small difference in rate can save thousands over the life of a loan.

• Keep payments manageable: A good rule of thumb is that total monthly debt payments shouldn’t exceed 36% of your gross income. Staying within this range helps you maintain financial stability and keep your budget balanced.

• Plan for the unexpected: Build an emergency fund to cover several months of expenses. That way, if you lose your job or face an unexpected cost, you can stay on top of loan payments without falling into bad debt.

• Monitor your credit: Good credit can unlock better rates and more favorable borrowing terms. Paying on time and keeping balances low will strengthen your credit score over time.

Using debt wisely isn’t about avoiding risk altogether. Rather, it’s about balancing opportunity with responsibility. When managed well, good debt can be a stepping stone to greater financial security, not a burden that holds you back.

Paying off bad debt takes consistency, strategy, and a bit of patience — but the payoff is worth it. The goal isn’t to eliminate all borrowing, but to free up cash flow so you can focus on using debt more productively in the future.

Here are a few proven ways to get started:

• Tackle high-interest balances first: Credit cards and payday loans typically charge the steepest rates. Using the avalanche method, paying these off first saves the most money over time.

• Consolidate strategically: If you’re managing multiple balances, a debt consolidation loan or balance transfer card with a 0% introductory APR can simplify repayment and reduce interest costs while you work to get ahead.

• Create a realistic budget: Track where your money goes and redirect extra funds toward debt payments. Even small adjustments, like cutting unused subscriptions, can make a meaningful difference over time.

• Negotiate with lenders: Some creditors will lower your interest rate or set up a payment plan if you’ve been a reliable customer or demonstrate financial hardship. It never hurts to ask.

• Avoid adding new debt: Focus on repaying what you owe before taking on new obligations. Once you’ve cleared high-interest balances, you can begin rebuilding your credit and saving more aggressively.

Before borrowing, ask whether the debt will increase your long-term financial security or simply add strain to your budget. By borrowing with intention, keeping balances manageable, and paying on time, you can use credit as a stepping stone toward your goals.

This article was edited by Alicia Hahn.