The distinction between good and bad debt comes down to one question: does this debt fund something that increases or creates value, or does it fund consumption? That's the framework.
Good Debt (Low Rate + Value-Creating Asset)
- •Mortgage: Funds an asset that typically appreciates + builds equity over time. At 7% with home appreciation of 3–4%, net cost of borrowing is ~3–4%.
- •Student loans (STEM/medicine/law): Expected return on income can far exceed cost of debt. RN salary increase of $40,000/year vs $50,000 in student loans = fast ROI.
- •Business loans: Borrowing to fund equipment or inventory that generates revenue — cost of debt lower than business return.
- •Investment property: Cash-flow-positive rental property — monthly income exceeds mortgage cost.
Bad Debt (High Rate + Depreciating Asset or Consumption)
- •Credit card debt at 20%+: Guaranteed 20%+ return on payoff, funds consumption that's already been consumed
- •Payday loans: Effective APRs of 300–400%. Never justified.
- •Auto loans on depreciating cars: A $50,000 car at 8% for 60 months costs $8,000 in interest on an asset worth $30,000 at end of loan
- •Buy now, pay later (BNPL) for consumer goods: Often 0% teaser → 30%+ if missed payment
The Gray Area: Contextual Debt
Car loans, medical debt, and some student loans are neither clearly good nor bad. A 4% car loan on a used car needed for work is defensible. A 10% auto loan on a luxury vehicle is not. Medical debt that prevents bankruptcy is necessary but still harmful. Context matters.
Use the "rate vs return" test: If the interest rate on the debt exceeds the expected return on the alternative use of that money, pay off the debt first. At 8% mortgage rate vs 8% expected stock return — it's roughly a wash. At 22% credit card vs 8% stock return — pay the card.
The ideal balance sheet: Carry only debt at rates below expected investment returns (mortgage, subsidized student loans), and aggressively eliminate high-rate consumer debt (credit cards, personal loans above 8%). No debt is pure good or pure bad — rate and purpose decide.