Good Debt vs. Bad Debt

A good debt is used for purchase of productive or appreciating assets or useful services. Thus, a home loan, an education loan or a business loan can be considered good debt. A housing loan gets you ownership of the house while an education loan or a business loan can improve your employment and income prospects.

On the other hand, a bad debt goes towards purchase of depreciating assets or towards unnecessary expenses.

However, there is a fine line between good debt and bad debt. After all, the definition itself is a bit subjective. Let’s look at a few examples.

Is Car Loan a Bad Debt?

Yes, a car is a depreciating asset. A car loses a good portion of its value the moment you drive it off the showroom.

However, a car purchase may not be an unnecessary expense. In some cases, the utility of car ownership may far outweigh the cost of a loan. If you stay in a city with poor and unreliable public transport, the utility of a car is high. The convenience of ferrying your kids to the school or elderly parents to the hospital safely and comfortably far outweighs the costs. This applies to any vehicle purchase. A car or a bike purchase can reduce commute time, enhance productivity, and even improve health and family harmony.

What about Credit Cards?

A credit card, if used responsibly, can help you manage cashflows. You get an interest-free credit period. And sometimes even discounts, cashbacks and reward points that may have some monetary value. Good debt.

At the same time, if a credit card gets you to overspend or if you scramble every month to make the minimum payments on your credit card, you are on path to financial ruin. Bad debt.

Sometimes, taking a loan makes plain mathematical sense. Think about No-cost EMIs on credit cards. You could pay Rs 60,000 upfront. Or pay Rs 10,000 per month for the next 6 months. No extra payment (except minor GST amount). Unless such schemes drive you towards unnecessary purchases, I don’t see anything wrong with such schemes.

What Makes Any Debt a Good Debt?

A Good Debt shall have following properties.

  • Is affordable.
  • Is used for productive activity or purchase of appreciating assets and useful goods or services.
  • Is NOT used for speculative activities such as dabbling in stocks or derivatives.
  • Is NOT spent on needless or unnecessary items or services.
  • Does NOT make you overspend.
  • Does NOT go towards keeping up with the Joneses or making lifestyle statements.

Every debt, good or debt, must be repaid. Remember too much debt can turn good debt into bad debt. And that’s where affordability part comes in.

It Depends on You Too

A borrower’s behaviour can make any debt good or bad.

There is a difference between taking a personal loan or using a credit card to purchase a laptop worth Rs. 25,000 for your daughter’s online school AND using loan or card to purchase an expensive phone for Rs 1 lac.

Both purchases are expensive gadgets. In both cases, you don’t have the money to pay upfront. However, you can’t term using a credit card to purchase a laptop as irresponsible. Daughter’s education is a NEED. Expensive phone is a WANT.

Yes, you may have messed up the financial planning. Yes, the debt needs to be paid on time. Still, the credit card or personal loan allows you to ensure continuity in daughter’s education. How can such debt be bad?

There are social media warriors, people of influence who term all debt as bad debt. For them, home loans are bad. Personal loans are bad. Swiping credit cards is evil. Not sure if I should call it their privilege or snobbery. Yes, debt is risky if you are not responsible.

However, it is unfair to make sweeping statements. Assuming your followers to be unintelligent is unfair. Not all debt can be bad. Their statements sometimes show little regard for human behaviour and their simple needs and desires. They look at everything from the vantage point of their spreadsheet models. Spreadsheet models would never assign any value to utility of purchases or emotional security.

Saving up is not an option for everyone. You would have to save for 15-20 years to buy a house without a home loan or 2-3 years to buy a car without a car loan. I am not saying that you go on a buying spree using loans and credit cards. Exercise discretion. Don’t overspend. Don’t borrow that you can’t repay.


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