This is an excerpt from Dollar Scholar, the Money newsletter where editor Julia Glum teaches you the modern money lessons you NEED to know. Don’t miss the next issue! Sign up to money.com/subscribe and join our community of over 160,000 scholars.
Giant shrimp. Same difference. Good morning.
These are some of my favorite oxymorons, which are phrases that combine contradictory words for rhetorical effect. (Another fun one is the Dolly Parton quote “You’d be surprised how much it costs to look so cheap.”) An oxymoron is a figure of speech often intended to add humor to a literary work…
…or to confuse personal finance journalists like myself.
Seriously: I’ve been tripped up by the term “good debt” for years. I write all the time about how critical it is for people to meet their obligations and minimize the balances they carry with them from month to month. I urge readers to avoid debt, not accumulate it. And now you’re telling me debt can be a good thing?!
I’m tired of this oxymoron making me feel like an idiot.
What is “good” debt and how does it differ from “bad” debt?
Adrianna Adams, a certified financial planner at Domain Money, tells me that good debt includes liabilities that 1) increase my net worth, 2) significantly improve my life, and/or 3) provide future value.
Take a mortgage for example: it’s an extremely expensive debt that will take me decades to pay off, but I end up with an appreciating asset that has significant value. (Some financial experts say owning a home is the key to building generational wealth, though Dollar Scholar has previously debunked this as the only way to unlock the American dream.)
Student loans also tend to qualify as good debt. As with a house, I’m taking on that debt while working toward the larger goal of getting a college degree which, in turn, will increase my ability to earn a higher income. Research shows that young workers with college degrees outearn their high school graduates by $22,000 a year.
To be clear: Having debt is extremely normal. According to a recent report from the New York Federal Reserve, Americans collectively have $17.5 trillion – to a T – in household debt.
And having debt is actually necessary to build my credit, says Keith Jones, senior financial advisor at Empower.
That’s because credit scores are based on factors like your payment history, length of credit history, credit mix, and credit utilization ratio. Having multiple types of debt can contribute to my credit mix, making it more diverse, which sends a signal to lenders that they can handle paying off multiple types of debt at once.
Sure, it’s a strange time to be a borrower. The Fed has raised rates 11 times in an attempt to curb inflation, making it extremely expensive to borrow money. A July survey by Northwestern Mutual found that the average American’s personal debt is $21,800 not counting mortgages; More than a third of those surveyed said they were already at or approaching their highest debt level ever. And that’s before student loan payments begin again in the fall.
This is where “bad” debt becomes a major factor. Under the pressure of having to make ends meet, borrowers tend to look for solutions that lead them to take on bad debts, easily identifiable by their high interest rate.
Jones says if I have debt with an interest rate higher than the expected rate of return on my investment portfolio, usually around 10%, it is considered negative. Common examples include credit card debt and payday loans.
And here’s the kicker: Having bad debt can actually lead to me having more bad debt.
For example, let’s say I have a lot of credit card debt from month to month and am not making payments on time. This will decrease my credit score, putting low mortgage rates out of reach and ultimately causing my debt to snowball.
Therefore, Jones advises me to be aggressive in paying off bad debt. Adams suggests reaching out to a financial planner to learn more about options like debt consolidation, refinancing, and negotiating with my credit card company.
I also don’t want to let too much good debt accumulate.
“Even though debt may be considered ‘good,’ it is still debt and something you have,” Jones says. “If you have too much debt overall, it can impact your ability to save and allocate your money to achieve your financial goals.”
The bottom line
Good debt is low-interest debt that increases in value and/or helps me increase my net worth (think student loans or a mortgage). Having Some good debt can improve my credit score, but I have to be careful not to overdo it lest it turn into bad debt.
More from Money:
Should I worry about the national debt?
Is it ever okay to be emotional with money?
How should I prepare for a recession?