Episode 6: How do I know the difference between good debt and bad debt?

The word debt often comes with a strong negative reputation. When you think about debt, you might imagine stress, overdue bills, and huge interest charges–extra money you must pay back on top of the original amount you borrowed. But not all debt looks like this. Just as people have good and bad habits, there are good and bad types of debt. Instead of demonizing and being afraid of debt, the key is knowing the difference between the two, to understand how your choices today can shape your future. 

Debt is simply money that you borrow with the promise to pay it back, usually with interest. It can come from many sources, like credit cards, student loans, or mortgages: always involving an agreement between the borrower and the lender. In other words, debt allows you to use money you don’t currently have! People often take on debt to afford big expenses like college, cars, or homes that they couldn't otherwise pay for upfront. While often overwhelming, debt helps you reach important life goals.

 Nobody’s saying that debt isn’t scary! The average American adult owes more than $104,000 in debt, according to a recent Experian consumer debt study. That kind of debt is actually the cost of one hundred iPhones, of five hundred different pairs of designer shoes, and about the cost of a BMW. 

But let’s actually break down where this debt comes from! Most of it is good debt.  Good debt is money borrowed for something that will grow in value or increase your ability to earn in the future. Think of it as a tool: when used wisely, it can help you reach goals that might be otherwise out of reach. Student loans, for example, are considered good debt because college degrees significantly boost your future earning potential. The median weekly earnings for someone with a four-year degree are about 67% higher than for someone with only a high school diploma. Over time, that income can more than repay the cost of your loan.

To start with, the largest share of American debt comes from mortgages (debts to buy homes) , while it’s the largest kind of American debt today, it can be considered “good” because homes and property often grow in value. Student loans are the second largest as investments in skills and earning potential.  Education builds specialized knowledge, credentials, and job qualifications that increase your skills and future earning potential, opening doors to higher-paying careers, so a debt that helps you attain a career that will help you pay it off and make more money then if you didn’t have the debt is worth it! 

Let’s look at Natalie Kim She studied engineering at UT Austin, taking out $25,000 in student loans at a 5% interest rate. After graduation, she lands a job at an engineering company making $70,000 a year–about $15,000 more than what she could have earned with just a high school diploma. That extra salary allows her to comfortably make her student loan payments, and within just a few years, her education has basically paid for itself. Beyond the paycheck, Natalie also gains access to internships, professors, and a professional network that keep opening doors for her long-term, so when she starts working for a startup, they provide advice, support and even investment in her company. She took on debt, but used it to fuel growth.

Then we move into the type of debt we call “bad”. That doesn’t mean that people in those types of debt are bad (diabolical behavior) but that it’s harder to get out of them. Auto loans, coming third as the most common type of debt,can be risky if overspent on luxury, making them sneakily become a bad debt, especially when there’s interest piling up over time. The problem is worsened by high interest rates—the higher the interest, the faster your debt snowballs into something harmful. Credit cards, for example, can carry interest rates over 20%.

Think of interest as money that you pay as a penalty for taking out a loan. When you take out a loan, what you’re doing is taking out money that somebody else has already put in wherever you took the loan from. The assumption is that you will, when you can, pay that money back in full. But chances are, you’re not getting a loan from your parents or your friends. The loan money for your student loans or mortgage is coming from a random persons’ account or taxes. For taking that money, the bank or other financial institution  you take the money from will want you to give extra for the privilege of using their money. That’s interest - it’s usually a percentage of your overall debt, and it causes your debt to increase over time. Most debts have them, and they can get pretty severe. Going into debt, especially with high interest rates and monthly payments you can’t make, can be dangerous.

Let’s look at Brandon, a finance major who’s always chasing TikTok trends, who takes out a huge loan to buy a Porsche. The car loses value the moment he drives it off the lot as he proceeds to gain a mileage to rizz girls, dents his car for the clout and paints it black for the vibes. This shows depreciating value, something that steadily goes down in worth over time Since the Porsche doesn’t help him earn more, the car loan quickly becomes a drain on his finances, especially with high interest. At first, since he only paid off like 10% of the price of the car, he now has to pay back the remaining 90%. But because of the 5% interest rate, he starts paying off more interest than he does from the 90%. In a year, the Porsche gets repossessed because he couldn’t pay off his loans and defaulted (basically ceased from paying) which came with unfortunate consequences.

 On the other hand, Ravi, a primary school teacher who makes a lot less money than Brandon, buys a modest used Toyota with money saved from his part-time job, and later upgrades to a Kia he can pay off within a year, paying more than 50% of it up-front. . His car loan is within his means, and it helps him reliably commute to school and work. For Ravi, he recognizes that the value of his car will keep going down over time, so he has to compensate for that by paying as little in interest as possible.

While this sounds overwhelming, not all this debt is harmful. Most comes from investments that build long-term value, like education or homeownership. The main thing to remember is to see debt as a way to bring value into your life - if it authentically does that with potential risks you can manage, then it’s probably worth it. 

Even though some auto loans are spending traps, an affordable auto loan for a reasonably priced car can also be a smart choice if it enables you to get to work or school reliably. Similarly, a reasonable mortgage on a home—a long-term loan used to purchase property—also builds equity, which basically means the portion of the home you truly own (not in cash, but in property value). Over time, as you pay down your loan and the home’s value rises, your equity grows. In many cases, a mortgage payment can even be less than renting long term. Jacob’s Toyota loan might not be glamorous like Brandon’s Porsche, but because it’s modest and functional, it works more like Natalie’s degree: it enables income and stability, not stress.

For example, imagine you're a high school senior who dreams of becoming an engineer. You take out a $20,000 student loan at a 5% interest rate (meaning the lender charges you 5% of the borrowed amount each year for the privilege of borrowing) to complete your degree. After you graduate, you land a job paying $15,000 more per year than you could have earned without a degree. After just two years, you earned back the cost of your loan, and for the rest of her career, that extra income keeps growing. The debt wasn’t necessarily “bad”, it was beneficial.

Potential debt with a reasonable student loan:

This shows how interest can steadily increase the amount you owe if ignored. But once you graduate and land a job paying $15,000 more per year than you could have earned without a degree, the math flips in your favor. After just two years, you’ve already earned back the cost of your loan—and for the rest of your career, that extra income keeps growing. 

On the flip side, any loan is definitively bad when the math just never is in your favour. Auto loans become"bad" when, like Brandon, you can’t afford the car and overspend on luxury. In these cases, you’re not only losing money to depreciation, but also to interest, making the purchase doubly expensive. Contrast that with Ravi’s choice: one car keeps him financially mobile, the other keeps Brandon financially stuck.

For you as a teen, understanding this difference early is important. The moment you open your first credit card, the financial institutions around you start keeping a secret book of all the money you ever take out and pay back, and then use it to give you a SAT score for debt. That’s your credit history, the record of your borrowing and repaying, which influences your ability to get good loan rates, to rent, or even get jobs. Debt is a big part of your credit score - and debts you can’t pay off are the worst for it. Just like any class, you have to put in the work to get the scores you want! Natalie’s discipline with her student loan shows how planning ahead sets you up for long-term stability, while Brandon’s overspending shows how quickly bad choices can spiral.

To avoid falling into bad debt, it helps to follow a clear set of guidelines: 

1. Live with a budget: A budget is simply a plan for how you’ll spend and save your money. It matches what you earn with what you spend, helping you prioritize essentials like food, rent, and savings before extras. Without one, it’s easy to overspend and turn to credit cards to cover gaps. With a budget, you can see exactly where your money is going, cut unnecessary costs, and avoid debt before it even starts. Natalie budgets carefully to stay on top of her student loans, while Ravi struggles without one. Check out our article on budgeting here
2.  Avoid impulse buying: Many small, unplanned purchases—like snacks, clothes—add up quickly. A simple way to control this is by using cash for day-to-day spending and giving yourself a “24-hour rule.” If you want something that isn’t essential, wait at least a day before buying it. Most of the time, the urge will pass, saving you money and keeping your credit card balance low. This is what Ravi  practices, while Brandon rarely does.
3. Pay attention to interest rates: Remember, a credit card with a 20% rate can turn a small $100 balance into $120 in just a year if unpaid. Knowing the rates on your loans helps you make smarter choices—like paying off high-interest debts first and avoiding new borrowing that could spiral out of control. Brandon learned this the hard way with his Porsche loan, while Natalie avoided it by taking on low-interest student debt that produced real returns.
4. Buy Now, Pay Later:“Buy Now, Pay Later” programs may look convenient, but they’re still loans. While splitting payments into installments can help with essentials, it can also trick you into spending more than you can afford. Missing just one payment can create late fees or interest, making your purchase more expensive than it seemed.  Brandon might see it as a quick fix, but Jacob knows better.
5. Build an emergency fund: Life is unpredictable: cars break down, phones crack, and medical bills pop up when you least expect them. Without savings, these emergencies often force people into high-interest debt. An emergency fund acts as a safety net, giving you cash to fall back on so you don’t have to swipe your credit card. Even starting small, like saving $20 a month can give you peace of mind and financial independence.  This is especially important for someone like Ravi, whose lower income makes surprises more dangerous to his finances.

Managing debt well is as important as deciding whether to take it on in the first place. Ultimately, good debt can help you grow, while bad debt holds you back. Before borrowing, think beyond the excitement of the purchase itself – consider its long-term impact on your finances, your goals, and your independence.  Natalie, Brandon, and Ravi show us three different paths: one where debt empowers, one where it traps, one where it sustains, and one where it challenges.