What is the difference between “good debt” vs. “bad debt”?
"The word ""good"" was used in contrast to ""bad"" but these words are misused here.  There are three kinds of debt: Debt for spending. Never go into debt to buy consumables, go out for a good time, for vacations, or other purchases with no lasting financial value. Debt for depreciating assets, such as cars and sometimes things like furniture. There are those who put this in the same category as the first, but I know many people who can budget a car payment and pay it off during the life of the car. In a sense, they are renting their car and paying interest while doing so. Debt for appreciating, money-making assets. Mortgage and student loans are both often put into the good category. The house is the one purchase that, in theory, provides an immediate return. You know what it saves you on the rent. You know what it costs you, after tax. If someone pays 20% of their income toward their fixed rate mortgage, and they'd otherwise be paying 25% to rent, and long term the house will keep up with inflation, it's not bad in the sense that they need to aggressively get rid of it. Student loans are riskier in that the return is not at all guaranteed. I think that one has to be careful not to graduate with such a loan burden that they start their life under a black cloud. Paying 10% of your income for 10 years is pretty crazy, but some are in that position. Finally, some people consider all debt as bad debt, live beneath their means to be debt free as soon as they can, and avoid borrowing money." I think people are conflating two orthogonal sets of terms. Unsecured/secured and good/bad are not synonyms. Debt may be secured or unsecured. If I take a loan against a car or house it is typically secured, so the object is collateral against the loan. Bad debt in financial terms is a loan that is not expected to be recovered. A bank might write off a loan or a portion of a loan as bad debt if the borrower goes bankrupt or into administration for example. Both secured and unsecured loans may be considered bad debt. I think the context in which the question is being asked is how to distinguish between sensible and inadvisable borrowing. An extreme example of inadvisable borrowing would be to buy a PC on a store card. PCs devalue very quickly and a store card may charge 30% APR, so paying the minimum off each month would mean paying  more than twice the sticker price for a product that is now worth less than half the original borrowed amount. On the other hand, a 3% mortgage when borrowing less than 60% of the value of a property is a good bet from a lender's perspective, and would be a good debt to have (not as good as no debt, but better thhan a high APR one). "Here's what Suze Orman has to say about it: Good debt is money you borrow to purchase an asset, such as a home you can afford. History shows that home values generally rise in step with the inflation rate, so a mortgage is good debt. Student loans are, too, because they're an investment in the future. Census data pegs the average lifetime earnings of a high school graduate at a million dollars below that of someone with a bachelor's degree. Bad debt is money you borrow to buy a depreciating asset or to finance a ""want"" rather than a ""need."" A car is a depreciating asset; from the day you drive it off the lot, it starts losing value. Credit card balances or a home equity line of credit that's used to pay for indulgences—vacations, shopping, spa days—is bad debt." "In general, all forms of debt are bad, as they keep you tied to a financial institution and can be an emotional burden for many. In the book Payback (by Margaret Atwood), debt is even described as a sin. However some forms of debt are necessary and some can help create wealth. ""Good"" debt: a mortgage - to purchase a home, which is an asset that usually appreciates in value.  Necessary debt: car loan or lease - only when there is no other mode of transportation to get to work. Really bad debt: unpaid credit cards - for dinners out." "None of the previous answers (which are all good) mention margin accounts (loans from your broker).  You may also have heard them described as ""leverage"".  It may seem odd to mention this rather narrow form of debt here, but it's important because overuse of leverage has played a large part in pretty much every financial crisis you can think of (including the most recent one).  As the Investopedia definitions indicate, leverage magnifies gains, but also magnifies losses. I consider margin/leverage to be ""bad"" debt." First of all debt is a technology that allows borrower to bring forward their spending; it's a financial time machine. From borrowers point of view debt is good when it increases overall economic utility.  A young person wants to bring up a family but cannot afford the house. Had they waited for 30 years they would have reached the level of income and savings to buy the house for cash. By the time it might be too late to raise a family, sure they'd enjoy the house for the last 20 years of their life. But they would loose 30 years of utility - they could have enjoyed the house for 50 years! So, for a reasonable fee, they can bring the spending forward.  Another young person might want to enjoy a life of luxury, using the magical debt time machine and bringing forward their future earnings. They might spend 10 years worth of future earnings on entertainment within a year and have a blast. Due to the law of diminishing marginal utility - all that utility is pretty much wasted, but they'll still will need to make sacrifices in the future. The trick is to roughly match the period of debt repayment to the economic life of the purchase. Buying a house means paying over 30 years for an asset that has an economic life of 80 years+, given that the interest fee is reasonable and the house won't loose it's value overnight that's a good debt. Buying a used car with a remaining life of 5 years and financing its with a seven years loan - is not a good idea. Buying a luxurious holiday that lasts a fortnight with 2 years of repayments, i.e. financing non-essential short term need with medium term debt is insane. The other question is could the required utility be achieved through a substitute at a lower cost without having to bring the spending forward or paying the associated fee. "From what I've heard in the past, debt can be differentiated between secured debt and unsecured debt.   Secured debt is a debt for which something stands good such as a mortgage on your house.  You have a debt, but that debt is covered by the value of an asset and if you needed to free yourself of the debt, then you could by selling that asset.   This is what is known as ""good"" debt.   Unsecured debt is debt that is incurred where the only thing that is available to pay it back is your income.  An example of this is credit card debt where you purchase something that couldn't be sold again to pay off the debt.   This is know as ""bad"" debt. You have to be careful about thinking that house debt is always ""good"" debt because the house stands good for it though.  The problem with that is that the house could go down in value and then suddenly your ""good"" debt is ""bad"" debt (or no longer secured).  Cars are very risky this way because they go down in value.  It is really easy to get a car loan where before long you are upside down.    This is the problem with the term ""good"" debt. The label makes it sound like it is a good idea to have that debt, and the risk associated with having the debt is trivialized and allows yourself to feel good about your financial plan.  Perhaps this is why so many houses are in foreclosure right now, people believed the ""good"" debt myth and thought that it was ok to borrow MORE than the home was worth to get into a house.  Thus they turned a secured debt into an unsecured debt and put their residence at risk by levels of debt they couldn't afford. Other advice I've heard and tend to agree with, is that you should only borrow for a house, an education and maybe a car (danger on that last one), being careful to buy a modest house, car etc that is well within your means to repay.   So if you do have to borrow for a car, go for basic transportation instead of the $40,000 BMW.  Keep you house payment less than 1/4th of your take home pay. Pay off the school loans as quickly as possible. Regardless of the label, ""good"" ""bad"" ""unsecured"" ""secured"", I think that less debt is better than more debt.   There is definitely such a thing as too much ""good"" debt!" "All very good answers for the most part, but I have a definition for Good and Bad debt which is a little bit different from those mentioned here so far. The definitions come from Robert Kiyosaki in his book ""Rich Dad Poor Dad"", which I have applied to all my debts. Good Debt - Good Debt is debt used to fund a money making asset, an asset which puts money into your pockets (or bank account) each month. In other words the income produced by that asset is more than all the expenses (including the interest repayments on the debt) associated with the asset. Bad Debt - Bad Debt is debt used to fund both money losing assets and non-assets, where the interest repayments on the debt are more than any income (if any at all) produced by the goods or services the debt was used to purchase, so that you need to take money out of your pockets (or bank account) each month to sustain the debt. Based on this definition a mortgage used to purchase the house you live in would be classed as bad debt. Why? Because you are making interest repayments on the mortgage and you have other expenses related to the house like rates and maintenance, but you have no income being produced by the house. Even a mortgage on an investment (or rental) property where the rent is not enough to cover all the expenses is considered to be bad debt. For the debt on an investment property to be considered as good debt, the rent would have to cover the full interest payments and all other expenses. In other words it would need to be a positively geared (or a cashflow positive) asset. Why is this definition important in distinguishing between good and bad debt? Because it looks at the cashflow associated with the debt and not the profit. The main reason why most investors and businesses end up selling up or closing down is due to insufficient cashflow. It may be a profitable business, or the value of the property may have increased since you bought it, but if you don't have enough cash every month to pay the bills associated with the asset you will need to sell it. If the asset produces enough cashflow to pay for all the expenses associated with the asset, then you don't have to fund the asset through other sources of income or savings. This is important in two ways. Firstly, if you are working and suddenly lose your job you don't have to worry about paying for the asset as it is more than paying for itself. Secondly, if you don't have to dig into your other source/s of income or savings to sustain the asset, then theoretically you can buy an unlimited number of similar type assets. Just a note regarding the mortgage to buy a house you live in being classed as bad debt. Even though in this definition it is considered as bad debt, there are usually other factors which still can make this kind of debt worthwhile. Firstly, you have to live somehere, and the fact that you have to live somwhere means that if you did not buy the house you would probably be renting instead, and still be stuck with a similar monthly payment. Secondly, the house will still appreciate over the long term so in the end you will end up with an asset compared to nothing if you were renting. Just another note to mention the definition provided by John Stern ""...debt is a technology that allows borrower to bring forward their spending; it's a financial time machine..."", that's a clever way to think of it, especially when it comes to good debt." "When I look at debt I try to think of myself as a corporation.  In life, you have a series of projects that you can undertake which may yield a positive net present value (for simplicity, let's define positive net present value as a project that yields more benefit than its cost). Let's say that one of the projects that you have is to build a factory to make clothing.  The factory will cost 1 million dollars and will generate revenue of 1.5 million dollars over the next year, afterwhich it wears out. Although you have the knowledge to build this wonderful factory, you don't have a million bucks laying around, so instead, you go borrow it from the bank.  The bank charges you 10% interest on the loan, which means that at the end of the year, the project has yielded a return of 400k. This is an extremely simplified example of what you call ""good"" debt.  It is good if you are taking the debt and purchasing something with a positive value. In reality, this should be how people should approach all purchases, even if they are with cash.  Everything that you buy is an investment in yourself - even entertainment and luxury items all could be seen as an investment in your happiness and relaxation.  If more people approached their finances in this way, people would have much more money to spend, William"
Hi guys, have a question from my uni finance course but I’m unsure how to treat the initial loan (as a bond, or a bill or other, and what the face value of the loan is).  I’ll post the question below, any help is appreciated.  “Hi guys, I have a difficult university finance question that’s really been stressing me out....  “The amount borrowed is $300 million and the term of the debt credit facility is six years from today  The facility requires minimum loan repayments of $9 million in each financial year except for the first year.  The nominal rate for this form of debt is 5%. This intestest rate is compounded monthly and is fixed from the date the facility was initiated.  Assume that a debt repayment of $10 million is payed on 31 August 2018 and $9million on April 30 2019. Following on monthly repayments of $9 million at the end of each month from May 31 2019 to June 30 2021.  Given this information determine the outstanding value of the debt credit facility on the maturity date.”  Can anyone help me out with the answer? I’ve been wracking my brain trying to decide if I treat it as a bond or a bill.”  Thanks in advance, You should definitely pay the remaining loan amount as quickly as possible. A loan in bad debts means that Bank has written it off books as its a education loan and there is no collateral. The defaults do get report to CIBIL [Credit Information Bureau India] and as such you will have difficulties getting credit card / new loans in future. Talk to the Bank Manager and ask can you regularize the loan?  There are multiple options you would need to talk and find out; 1. You can negotiate and arrive at a number. Typically more than the principal outstanding and less than interest and penalties charged. 2. You can request to re-do the monthly payments with new duration, this will give you more time. 3. May one time large payment and subsequent amount in monthly payments. At the end its Bank's discretion whether to accept your terms or not. Yes, a mortgage is debt.  It's unique in that you have a house which should be worth far more than the mortgage. After the mortgage crisis, many found their homes under water i.e. worth less than the mortgage.  The word debt is a simple noun for money owed, it carries no judgement or negative connotation except when it's used to buy short lived items with money one doesn't have.  Aside from my mortgage, I get a monthly credit card bill which I pay in full. That's debt too, only it carried no interest and rewards me with 2% cash back. Many people would avoid this as it's still debt. Think about India's government, and then think about Spain's.   Credit rating is a measure of risk of default. What government is more likely to default:  A developed, relatively transparent European government with mature industries and an educated populous.  Or a developing, relatively opaque SouthEast Asian government with a large amount of its populous uneducated, living in poverty.  Ask yourself, would you rather make a loan to Spain or India? Which is more likely to pay you back?  edit: Despite the fact that Spain needs a bailout, it already has a very mature, very advanced infrastructure/economy in place. With a little cash, the government can get that industrial machine working at efficiency again. "The basic equation taught in day one of accounting school is that Assets = Liabilities + Equity. My first point was that I looked at the actual financial statements published as of the end of the 2nd quarter 2017, and the total liabilities on their audited balance sheet were like $13 billion, not $20b. I don't know where the author got their numbers from.  My second point: Debt usually needs to be paid on prearranged terms agreed upon by the debtor and the debtee, including interest, so it is important for a business to keep track of what they owe and to whom, so they can make timely payments. As long as they have the cash on hand to make payments plus whatever interest they owe, and the owners are happy with the total return on their investment, then it doesn't really matter how debt they have on the balance sheet.  Remember the equation A=L+E. There are precisely two ways to finance a business that wants to acquire assets: liabilities and/or equity. The ""appropriate"" level of debt vs equity on a balance sheet varies wildly, and totally depends on the industry, size of the business, cash flow, personal preferences of the CEO, CFO, shareholders et al, etc.    It gets way more detailed and complicated than that obviously, but the point is that looking at debt alone is a meaningless metric. This is corporate finance and accounting 101, so you can probably find tons of great articles and videos if you want to learn more." Cars are not houses.  The comparison is apples to oranges.   Bad car loans actually can be good business for car dealers.  When someone defaults on their car loan they very quickly lose the car.  That car is then resold.   Default on a home loan and you don't even have to leave the house, and there is no way for them to take the house back from you.  It often takes a year or two for the bank and lawyers to get you kicked out of the house.   A car however is on wheels, it can easily be moved and taken back.  This article is some poorly researched 'sky is falling' click-bait. I don't have numbers on that, but I imagine the average student loan is much higher.  Stilll, student loans, due to their default-less nature, are a bit of a different beast IMO. I think student loans will put a prolonged drag on the economy, but I really don't see where the catalyst for a crisis would be. "This is the best tl;dr I could make, [original](https://www.theguardian.com/commentisfree/2017/sep/04/britain-addicted-debt-crash-2007-sub-prime-mortgages-personal-credit) reduced by 93%. (I'm a bot) ***** &gt; This is, of course, what determined the depth of the last crash, the wheeze of the collateralised debt obligation, which left no one able to distinguish between a good debt and a bad one.  &gt; Alex Brazier, executive director of financial stability at the Bank of England, warned last month that consumer loans had gone up by 10% in the past year, with average household debt having already eclipsed 2008 levels.  &gt; Student loan debt is counted separately from consumer loans, and stands at &amp;pound;13bn a year.   ***** [**Extended Summary**](http://np.reddit.com/r/autotldr/comments/6y43cq/we_are_addicted_to_debt_and_headed_for_a_crash_it/) | [FAQ](http://np.reddit.com/r/autotldr/comments/31b9fm/faq_autotldr_bot/ ""Version 1.65, ~204396 tl;drs so far."") | [Feedback](http://np.reddit.com/message/compose?to=%23autotldr ""PM's and comments are monitored, constructive feedback is welcome."") | *Top* *keywords*: **debt**^#1 **know**^#2 **year**^#3 **much**^#4 **loan**^#5" "The problems with ratings and the interpretation of ratings is that they are retrospective, and most people read them as prospective. They basically tell you that debtor is solvent right now. What does that mean? It means that the ratings are based on the audited financial statements of a company, government or other organization issuing debt. So, in the best case scenario where the rating agency is acting properly, they are still dependent on folks with fiduciary responsibility telling the truth. And even if they are telling the ""truth"", accounting rules make it possible to obscure problems for years in some cases. Municipal goverments are a great example of this... the general obligation bonds cities and even states with deep structural budget problems still get good ratings, because they are solvent and have sufficient operating cash to meet obligations today. But towards the end of a 30-year bond's life, that may not be the case anymore unless they dramatically alter their budgets. At the end of the day, ratings are one aspect of due diligence. They are useful screening devices, but you need to understand who you are lending money to by purchasing bonds and diversify your holdings to protect your wealth.  The problem, of course, is when the trustees of your pension fund invests in garbage assets after getting a sales pitch on the beach in Hawaii, then conveniently place all of the blame for that bad investment on the rating agency. You unfortunately have zero control over that." Did you read the article?  They weren't arguing whether or not the debt could be defaulted on.  They were arguing that one side can't unilaterally change the terms of the contract and decide to pay less.  Which seems like common sense, but whatever. "No idea what you are trying to say here.   You default on a loan, student or otherwise, by not paying.  That is what creates the default, but you still owe it.   Student loans actually can be discharged, but it is very uncommon and an uphill battle.  You have to prove ""undue hardship"" which has a rather high standard.  The last firm I worked at did manage to get a large amount of student loans discharged for someone who was in a car wreck and became a quadriplegic after incurring the student loan.  And even that was not an easy case,  my old firm was actually rather pleased at their success." Here is another way to look at it. Does this debt enable you to buy more car than you can really afford, or more car than you need? If so, it's bad debt. Let's say you don't have the price of a new car, but you can buy a used car with the cash you have. You will have to repair the car occasionally, but this is generally a lot less than the payments on a new car. The value of your time may make sitting around waiting while your car is repaired very expensive (if, like me, you can earn money in fine grained amounts anywhere between 0 and 80 hours a week, and you don't get paid when you're at the mechanic's) in which case it's possible to argue that buying the new car saves you money overall. Debt incurred to save money overall can be good: compare your interest payments to the money you save. If you're ahead, great - and the fun or joy or showoff potential of your new car is simply gravy. Now let's say you can afford a $10,000 car cash - there are new cars out there at this price - but you want a $30,000 car and you can afford the payments on it. If there was no such thing as borrowing you wouldn't be able to get the larger/flashier car, and some people suggest that this is bad debt because it is helping you to waste your money. You may be getting some benefit (such as being able to get to a job that's not served by public transit, or being able to buy a cheaper house that is further from your job, or saving time every day) from the first $10,000 of expense, but the remaining $20,000 is purely for fun or for showing off and shouldn't be spent.  Certainly not by getting into debt. Well, that's a philosophical position, and it's one that may well lead to a secure retirement. Think about that and you may decide not to borrow and to buy the cheaper car. Finally, let's say the cash you have on hand is enough to pay for the car you want, and you're just trying to decide whether you should take their cheap loan or not. Generally, if you don't take the cheap loan you can push the price down. So before you decide that you can earn more interest elsewhere than you're paying here, make sure you're not paying $500 more for the car than you need to. Since your loan is from a bank rather than the car dealership, this may not apply. In addition to the money your cash could earn, consider also liquidity. If you need to repair something on your house, or deal with other emergency expenditures, and your money is all locked up in your car, you may have to borrow at a much higher rate (as much as 20% if you go to credit cards and can't get it paid off the same month) which will wipe out all this careful math about how you should just buy the car and not pay that 1.5% interest. More important than whether you borrow or not is not buying too much car. If the loan is letting you talk yourself into the more expensive car, I'd say it's a bad thing. Otherwise, it probably isn't. I'm not sure we're talking about the same thing. I'm talking about making money off loans which weren't defaulted but on but were paid back with interest.  Anyway, in abstract preventing something bad absolutely counts as doing something good. The crisis could have been worse, and caused much more pain, hardship, and lost wealth. It was bad enough as it was, I'm personally glad it wasn't worse. "No. One of the key ideas behind a corporation is that an investor's liability is limited to the amount he invests, i.e. the amount of stock he buys. This is the primary reason why small businesses become corporations, even though one person owns 100% of the stock. Then if the business goes broke, he won't lose his house, retiretment fund, etc. He'll lose everything he had in the business, but at least there's a limit to it. (In some countries there are other ways to achieve the same results, like creating a ""limited liabililty company"", but that's another story.)" (a) you give away your money - gift tax The person who receives the gift doesn't owe any tax.  If you give it out in small amounts, there will be no gift tax. It could have tax and Estate issues for you depending on the size of the gift, the timing, and how much you give away in total.  Of course if you give it away to a charity you could deduct the gift. (b) you loan someone some money - tax free?? It there is a loan, and and you collect interest; you will have to declare that interest as income. The IRS will expect that you charge a reasonable rate, otherwise the interest could be considered a gift. Not sure what a reasonable rate is with savings account earning 0.1% per year. (c) you pay back the debt you owe - tax free ?? tax deductible ?? The borrower can't deduct the interest they pay, unless it is a mortgage on the main home, or a business loan. I will admit that there may be a few other narrow categories of loans that would make it deductible for the borrower. If the loan/gift is for the down payment on a house, the lender for the rest of the mortgage will want to make sure that the gift/loan nature is correctly documented. The need to fully understand the obligations of the homeowner. If it is a loan between family members the IRS may want to see the paperwork surrounding a loan, to make sure it isn't really a gift. They don't look kindly on loans that are never paid back and no interest collected.