Good Debt vs. Bad Debt: Do You Know the Difference?

Is owing money always a bad thing? It might surprise you that the answer is no—and there are actually two kinds of debt: good debt and bad debt. Here's how they're different, according to financial experts:

Good debt:

• Helps build future value or income
• Has manageable interest and payments
• Fits your budget

Bad debt:

• Pays for things that lose value over time
• Has high interest that compounds fast
• Creates ongoing stress

“Taking on debt can be helpful in certain situations,” says Kayla Brownrigg, a tax expert at TurboTax Canada. “It all comes down to what the debt is for and whether you can afford the payments.”

What does that mean for your day-to-day life? Let's look at some examples.

Good debt vs. bad debt: Questions to ask yourself

Going into debt is as easy as tapping your credit card too many times. Before you borrow, ask yourself these “gut check” questions:

• Does this help future me?
• Can I afford this without guessing?
• Would I still want it if I had to pay in cash?

Examples of good debt

Good debt is debt you can afford, and future you will be grateful for what it makes possible. For example:

• A mortgage that fits your income: you're building equity in a home and the mortgage payments are affordable, so your overall budget is still manageable.
• Student loans tied to realistic earnings: you're investing in your future ability to earn a good living, so you can pay off those student loansand live the life you want.
• Business loans with a plan: you incur debt with a reasonable interest rate that will help kick-start an income-earning business.
• Car loans, when they're essential: you need a car for work or to get to work, the loan amount is within your means, and you can also afford ongoing auto expenses like insurance, maintenance, and gas or EV charging.

Examples of bad debt

Bad debt is debt that future you definitely won't be grateful for. For example:

• Credit card balances carried month to month: high interest rates on credit card debt mean you could end up paying much more than your original purchase amount.
• Payday and high-interest loans: these can set you back financially, as your future income will have to go toward payments.
• Financing lifestyle purchases: using borrowed money to buy things you don't really need (including using “buy now, pay later” services) takes away from future income, and the items you buy usually depreciate in value.
• Debt that depends on perfect future income: if that income doesn't materialize, you'll have trouble making payments.

Good debt vs. bad debt isn't always black and white

Keep in mind that the same kind of debt can be good or bad depending on the terms, the interest rate, and the purpose:

• A personal loan with a reasonable interest rate can be good if you're using that money to contribute to your RRSP—but not so good if you're using it to make high-risk investments, like buying risky crypto or prediction bets.
• It's not what the loan's called, it's what you use it for. Be careful to avoid high-interest debt and predatory loans and scams.

How to avoid bad debt

“It's always better to avoid bad debt than to have to dig yourself out of it later,” says Brownrigg. Here are some tips.

• Pause before borrowing. Waiting a day or two before purchasing can help you skip impulse buys.
• Know the interest rate for each loan and be clear on potential fees.
• Avoid stacking payments, such as having multiple debts on “buy now, pay later” services.
• Build a small emergency buffer that you can use if you accidentally spend over budget.

How to pay down debt quickly

Got bad debt you want to clear off your plate? Follow these steps to get debt free:

1.     Make a list of all your debts—credit card debt, home loans, car loans, student loans, and anything else you owe—including balances and interest rates.
2. Choose whether you want to pay off the highest-interest debt first (avalanche method) or the smallest debt first (snowball method). Organize your debt list accordingly.
3. Stop adding new bad debt. A monthly budget can help with this, if you stick to it.
4.     Set a realistic payoff goal and start making consistent payments.

If you're having a hard time juggling multiple debts, these strategies might not be enough. One solution might be debt consolidation: bundling all your debt together so you have a single monthly payment and a lower interest rate. You'll need to work with a financial institution or debt consolidation company to arrange this.

Is there tax on debt?

“There's no tax on debt,” says Brownrigg. “And in some cases, your debt could help you save on taxes.” For example:

• If your debt was incurred specifically to earn income from a business or property, you might be able to claim the interest as a deduction.
• That income-earning “property” can include some kinds of investments, so long as they're in non-registered accounts. Dividends and earned interest count as income here; capital gains do not.
• Self-employed individuals can claim a portion of their mortgage interest as part of their business-use-of-home expenses.

Interest on personal lifestyle debt is generally not tax-deductible, says Brownrigg. “Remember that the tax treatment depends on how the money is used, not what the loan is called.”