How do I know the difference between 'good' and 'bad' debt?

Key takeaways

  • Debt incurred for bad reasons is debt that funds lifestyle expenses and leaves you with little to show for it.
  • Debt that funds your lifestyle expenses plus the interest on it will have to be repaid from your future earnings.
  • All debt will cost you in interest, but using credit to buy assets that increase in value – such as property - can create wealth.
  • Any credit that you cannot afford to repay, however, is bad.

Good financial habits involve only taking on debt when it is wise to do so and avoiding using debt when it is not a good idea to do so. People often refer to this as "good" debt versus "bad" debt although the lines are not always that clear.

What is it better to use debt for?

It is better to use debt for things that help you increase your future wealth or income.

So-called "good" debt could include:

A home or property loan

Most people need a loan to fund the ownership of property. Property is an appreciating asset that can grow your wealth possibly by more than the interest on the loan.

Funding a second property that can earn you rental income in future can also potentially increase your wealth.

A student loan

A student loan can be good debt if it ultimately results in you getting a qualification that allows you to earn a higher income.

A business loan

A business loan could be good debt if it results in you owning your own business that generates a growing income stream in the future. A business can also potentially be an asset you can sell when you decide you no longer want to own that business.  

These loans are typically regarded as good debt, but no loan is good if you cannot afford the repayments or if you have overstretched yourself.

If you default on the repayments you may impair your credit record. Also the interest on the debt and potential costs incurred by the credit provider attempting to recoup the credit, will accumulate.

A loan to fund an expensive home that you actually cannot afford could also be bad credit. A lender may find you can afford the loan repayments, but be unaware of financial pressures you face or will face in the future. You may then ultimately be forced to sell your property and may incur a loss doing so.

There is risk

Any investment in a property also involves some risk – it can turn out to be a bad investment if the area in which you buy experiences a surge in crime or homelessness, for example. A rental property can prove to be a loss-maker if you do not find good tenants.

A student loan could also end up being bad debt if you don’t get employment or you struggle to achieve the qualification. The same applies if you end up with a debt that you will struggle to repay on the income you eventually earn.

If studies will stretch you and your family financially, you may be better off finding a less expensive way to study initially – for example, online while working part time. You can always take a higher qualification later – when you can afford to do so.

Similarly, a business loan may turn out to be bad debt if your business fails or fails to generate enough income to enable you to repay the loan.

Weigh up the risks before you take on credit, err on the side of caution and take as little credit as possible – it always comes at a higher cost than buying something with savings. 

What debt is not good to take on?

Debt that is bad for you is debt that funds your lifestyle without increasing your wealth. It is something your future self will have to pay with interest.

So-called bad debt could include:


Infographic: Good debt vs bad debt

Credit that funds entertainment, food, clothing or travel

You may enjoy making these purchases, but afterwards you are left to repay them and they have little future value. You will still need to buy more food and clothing while you are repaying the debt.

It is better to fund lifestyle costs in accordance with your current income – in other words, live a lifestyle that fits your means.

Travelling can broaden your horizons, but you will enjoy your trips much more if you save for them rather than fund them with debt. You will travel further if you save before you travel and earn interest on your savings, rather than travelling first, incurring debt and paying off that debt with interest.

Credit used to buy furniture and appliances

Furniture and appliances can be necessities and you may be forced to buy some on credit. However, buying the expensive ones beyond your means can get you into a debt trap. Aim to save up for furniture and appliances rather than buying them on credit. Ultimately, they will cost a lot less and you will have more money to spend on other things you want.

Credit used to buy a vehicle

Most vehicles you buy depreciate by thousands of rands the minute you drive them out of the showroom, while the debt you owe on the vehicle increases with interest as long as it is outstanding.

Credit used to buy a vehicle can be particularly bad if you struggle to make the repayments and afford the associated costs of owning a vehicle – the insurance, fuel and maintenance costs.

A vehicle may be a necessity for your work or business, but if you are just starting out, choose a

 smaller cheaper vehicle to begin with, and only move to a more expensive one when you know you have saved for it or know you can afford the repayments.

If you drive a vehicle for longer than your repayment period, you can use some of your repayments to pre-fund your next vehicle. Saving towards a vehicle will make it cheaper to acquire, as you won’t need as much credit and you will incur less interest.

Credit card debt, overdrafts, personal loans and loan shark loans are often bad forms of debt. If you use a credit card wisely, spending on lifestyle expenses only what you can afford to repay each month, credit cards can be a convenient way of paying for transactions.

You will also enjoy a certain number of days of free credit.

However, it is easy to be undisciplined when you have a convenient way of paying. If you are unable to pay what you owe in full each month, the interest rates are high and your debt can quickly escalate.