The General Idea
In financial education, debt is often divided into two categories. "Good debt" is borrowing that is expected to build value or increase earning potential over time -- a mortgage on a home, student loans for a degree, or a business loan. "Bad debt" is borrowing for things that lose value or do not generate any return -- credit card balances from everyday spending, high-interest personal loans for consumable goods, or auto loans on more car than you need.
The distinction is useful as a general framework, but it is not absolute. A mortgage is generally considered good debt, but not if the payment is so high it leaves no room for savings. Student loans are considered good debt, but not if the degree does not lead to income that supports the repayment. Context matters.
Interest Rates Tell a Lot of the Story
One of the clearest indicators of whether debt is working for or against you is the interest rate. Federal student loans typically carry rates between 5-8%. Mortgages, depending on when they were locked in, might be anywhere from 3% to 7%. Credit cards, on the other hand, commonly charge 20-30% APR. At those rates, a $5,000 credit card balance generates over $1,000 in interest per year if unpaid.
When evaluating any debt, the interest rate relative to what that borrowed money is doing for you is a useful lens. Low-rate debt funding an appreciating asset is a fundamentally different situation than high-rate debt funding last month's groceries.
The Debt-to-Income Ratio
Lenders often look at your debt-to-income ratio (DTI) when deciding whether to approve you for a loan. DTI is your total monthly debt payments divided by your gross monthly income. A DTI under 36% is generally considered healthy by most lending standards, though requirements vary. If your DTI is above 43%, many conventional mortgage lenders will not approve a loan.
Even if you are not applying for a loan, DTI is a useful self-check. If more than a third of your gross income is going to debt payments each month, it limits your flexibility for everything else -- savings, emergencies, and day-to-day living.
This content is for general educational purposes only and does not constitute financial advice. Everyone's financial situation is different. Consider consulting with a qualified financial professional for guidance specific to your circumstances.