Good Debt vs Bad Debt
Not all borrowing is created equal
The Key Distinction
Good debt puts money in your pocket over time. It helps you acquire something that grows in value or increases your earning power. Bad debttakes money out of your pocket. It funds consumption — things that lose value the moment you buy them.
Key Concept
Ask yourself: “Will this debt make me richer or poorer in 5 years?” If the asset you’re borrowing for goes up in value or increases your income, it might be good debt. If it’s for something that depreciates, it’s almost certainly bad debt.
Examples of Good Debt
- Mortgage — property generally appreciates, you’re building equity, and you need somewhere to live anyway
- Student loan (UK) — graduates earn £100,000+ more over their career on average. UK student loans are uniquely forgiving (wiped after 40 years, repayments linked to income)
- Business loan — if used to generate revenue that exceeds the interest cost
Examples of Bad Debt
- Credit card spending — 20–40% APR on depreciating items
- Payday loans — can exceed 1,000% APR
- Car finance (PCP/HP) — a new car loses 15–35% of its value in the first year
- Buy-now-pay-later — encourages spending beyond your means
Interest Rate Comparison
| Debt Type | Typical APR | Category |
|---|---|---|
| Mortgage | 4–6% | Good |
| Student loan (Plan 5) | RPI + 0% | Good |
| Personal loan | 3–15% | Depends |
| Car finance (PCP) | 5–15% | Usually bad |
| Credit card | 20–40% | Bad |
| Store card | 25–40% | Bad |
| Payday loan | 100–1,500% | Terrible |
Debt Payoff Strategies
Avalanche Method (Mathematically Optimal)
Pay minimums on everything, then throw all extra money at the debt with the highest interest rate. When that’s cleared, move to the next highest. This saves the most money over time.
Snowball Method (Psychologically Powerful)
Pay minimums on everything, then throw all extra money at the smallest balance. The quick wins keep you motivated. Dave Ramsey’s favourite method.
Real-World Example
You have 3 debts: £500 store card (30% APR), £3,000 credit card (22% APR), £8,000 car loan (7% APR). The avalanche method tackles the store card first (highest rate). The snowball method also tackles the store card first (smallest balance). Sometimes both methods agree!
When to Consolidate
Debt consolidation means taking out one new loan to pay off multiple debts. It makes sense when:
- The new loan’s interest rate is lower than your existing debts
- You’re struggling to manage multiple payments
- You won’t run up the old debts again (cut up the cards!)
Warning
Never consolidate unsecured debt (credit cards) into secured debt (your mortgage) unless you’re absolutely sure. If you can’t pay your credit card, they chase you for the money. If you can’t pay your mortgage, they take your house.