What Teens Should Know About Good Debt & Bad Debt
Last updated July 20, 2021
Creating a strong financial footing starts with understanding what debt is, the different types of debt you will encounter, and how to make smart financial decisions. You may hear people talk about the benefits of taking on “good” debt (student loans) or that you should stay away from “bad” debt (high interest credit cards). We’ll walk you through what good debt and bad debt means.
What is Good Debt?
“Good” debt is low-interest debt that helps you increase your wealth or income over time. An example of good debt is student loans. Student loans are considered good debt because you are investing in your education and working towards a credential or degree that should lead to you earning more lifetime earnings than someone who does not pursue a credential or degree, which can justify the need to borrow the money. That said, too much of any kind of debt can quickly turn into bad debt.
What is Bad Debt?
“Bad” debt is any debts that hold you back from reaching the financial success you want. Credit cards are often considered a form of bad debt (and they can be) if you let them go awry. The reason credit cards are considered bad debt is because many credit companies are predatory, meaning:
- Many of them have high interest rates (around 25-30%).
- Some companies might encourage you to only pay the minimum statement balance instead of paying in full every month, which will draw out your debt even longer (and rack up some serious interest on the way)!
- Some companies will offer “rewards” or “incentives” to spend money on your card. This can lead you to spend money that you might not have.
Now, if you have a high-interest credit card and pay off your balance each month, then having a credit card isn’t a problem. But if you have a high-interest credit card and you are only paying the minimum balance every month instead of paying off your card, the debt will build up quickly (because of compound interest), and it will be much harder, and more expensive, to pay off your debt.
A note about car loans
Car loans can be considered a good debt or bad debt. It depends on a number of factors. If you receive a low interest rate on your car loan and can afford to cover your car payment and all of the associated expenses that come with being a car owner (gas, maintenance, parking tickets, etc.), then taking on a loan may not be an issue. A good rule of thumb is to buy an affordable (in your budget), gently used car, with a low interest rate that is reliable and has good gas mileage. Why? Because most cars are considered depreciative assets - meaning they lose value over time.
Whether it’s good debt or bad debt or a combination of the two, debt is still debt. If you are not clear on how to manage it, you can easily ruin your credit and your financial future, which may take you several years (or decades) to recover. Make sure you have a game plan in place for how you plan to pay off your debt and how much it really costs to take on.