Schwab MoneyWise ®
Schwab MoneyWise®

Good Debt vs. Bad Debt

Understanding the difference.

Our Two Cents

As a general rule, try not to borrow money or use your credit cards for vacations or things that depreciate in value, such as cars and home appliances.

It might sound strange, but not all debt is "bad." Certain types of debt can actually provide opportunities to improve your financial future.

To make smart decisions about if, when, and how much to borrow, you need to understand the difference between "good" and "bad" debt, and how to manage it. That way, you can avoid being part of the negative 2016 debt statistics in America:

  • Consumer debt is $12.25 trillion.
  • Americans are paying an average of $6,658 in interest per year.
  • The average household with debt owes $15,310 on their credit cards.
  • Nearly 80% of American families have a credit card, and almost half carry a balance on their credit cards.

It's not all bad

Good debt should ideally be low cost and have potential tax advantages. Here are two examples:

  • With mortgages and home equity lines of credit, you’re borrowing to own a potentially appreciating asset, and it may be tax-deductible. You can deduct the interest on mortgage debt of up to $1 million on your primary and/or secondary residence, whether the loan is to purchase the home or make major improvements. The same is true on up to $100,000 of home equity debt, such as a home equity line of credit, which can be used for any reason. (As always, be sure to check with your tax advisor.)
  • With student loans, rates are comparatively low, and interest can be tax-deductible, depending on your income. Benefits include enhanced career opportunities, which will increase your earning potential in the long run.

Debt that can work against you

Generally speaking, try to avoid debt that is high cost and isn’t tax-deductible, such as credit cards and some auto loans.

  • High interest rates will cost you over time. Credit cards are usually necessary and are helpful as long as you pay them off every month and aren’t accruing interest.
  • If you purchase a new car, you’re borrowing on something that immediately loses value as soon as you drive it off the lot. A used car is usually more cost effective, but still loses value over time. Do your research to make sure you’re getting the best APR possible and choose a vehicle you can truly afford.
Safe debt guidelines
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Guidelines to help manage debt
If your debt is… Then…
30% or less of your pre-tax income You’re in great shape
Between 31% and 36% You’re doing OK
Between 37% and 40% Beware, you’re on the borderline
More than 40% Red flag warning

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