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Not all debt is bad. It may surprise you to know that there are significant differences between good debt and bad debt. Here's what you need to understand.

We’ve all heard the expression that the only thing guaranteed in life is death and taxes, right? Well, over the last couple of decades it appears that debt has also become another inescapable fact of life. According to Statistics Canada, we owe an average of $1.79 in credit market debt for every $1 dollar of household disposable income they earn. In other words, spending is exceeding money brought in.

But don’t be too quick to demonize debt. Believe it or not, there is such a thing as good debt. To keep your personal finances in order, it’s vital to understand the difference between good and bad debt.

Good Debt vs. Bad Debt

Generally speaking, the main difference between good and bad debt is how debt affects your personal bottom line. If the debt is going to act like an investment and increase your net worth or if it’s going to have reliable future value, it would be considered good debt. If, however, you incur debt for items that will decrease your net worth or lose significant value over time, that debt would be considered bad. Examples of each type of debt that follows here can make the distinction easier to understand.

What Is Considered Good Debt?

A mortgage is a positive example of debt because owning a home boosts your net worth. Property is an asset that usually grows in value over the years. Likewise, as long as you make regular payments, home equity loans and lines of credit can fall into the good debt category. These kinds of loans tend to be used by people to pay for renovations that will improve the value of their home or be used as a consolidation loan (more about this below) to pay down high-interest debt from other sources. Here are some examples:

  • Because mortgages, home equity loans and lines of credit tend to have lower interest rates than other kinds of loans, repayment is much more manageable, further underscoring their categorization as good debt.
  • Taking out a student or personal loan for tuition to pursue higher education or improve your skills and job prospects is also considered good debt. Education and improving skills are investments in your future that should help you secure a higher paying job, and thus, increase your overall net worth.
  • debt consolidation loan could be considered good debt, depending on the circumstances. This is when you take out a single, larger loan to pay off multiple smaller loans with higher interest. It’s “good” because you’re paying much lower interest than a credit card (which usually charge 19% or higher). For instance, Loan Connect offers interest rates starting as low as 4.60% and Loans Canada offers interest rates starting at 5.15%. That could save you a bundle in interest charges.

Learn more about Loan Connect

What Is Considered Bad Debt?

Bad debt is debt incurred for items that don’t add to your net worth and have no long-term value. Credit card debt is a major cause of bad debt in Canada. Most of the items we charge to credit cards – like clothing, restaurant meals and electronics – have no long-term value. And no, even feel-good items like vacations don’t qualify as smart debt. Sadly, good memories don’t trump bad debt. Let’s look at some scenarios:

Adding to credit cards’ bad debt rap is their incredibly high (around 19% and above) interest rates. Those high APRs mean that, if you don’t pay off your balance each month, your debt can quickly snowball out of control. A low-interest rate credit card or 0% balance transfer credit card can alleviate some of the debt burdens, but they still don’t qualify as good debt.
While credit card interest is certainly bad debt, payday loans are even more problematic. Because of their astronomically high-interest rates (which can equal a markup of 300% to as much as 600%), they qualify as bad debt and should be avoided if at all possible. The Government of Canada even warns consumers about the dangers of these type of loans.

Car loans fall into a grey area and cause disagreement between financial experts when it comes to classification as a good or bad debt. On one hand, a car loan seems like bad debt because cars depreciate rapidly and incur many costs, like gas, insurance and maintenance. On the other hand, if you need a car to get to a higher-paying job or if you have a business where having a vehicle could significantly increase your business revenue opportunities, then a car loan could be classified as good debt. The possibility of writing off some of your car expenses against your income would nudge it further into the good debt category.

The bottom line? Look for the best car loan rates in Canada in order to minimize the interest charges that you pay over the long-term. For instance, we're big fans of Loan Connect because interest rates start at 4.60% and you can get approved in as little as 5 minutes.

Learn more about LoanConnect

What Is A Good Debt To Income Ratio?

If you’re still finding it difficult to get a clear picture of what constitutes good or bad debt, a straightforward solution is to figure out your debt-to-income ratio. To figure out your “DTI,” you begin by adding up all your monthly debt (such as mortgage payments, home and auto insurance costs, credit card payments, etc.). Next you add up your monthly income (like your pay cheque and any other sources of income). Then divide your total monthly debt by your gross monthly income and then multiply the total by 100 to get the number as a percentage.

For example, if you make $5,000 a month and your debts add up to $2,500, your DTI is 50%. Generally, a DTI of 43% or over is not good. The ideal debt-to-income ratio is 36% and under.

When Is Debt Consolidation A Good Idea?

Debt consolidation is when a person with a lot of high-interest debt from multiple sources (like credit cards and personal loans) combines them into one larger but more manageable debt. As mentioned previously, under the right circumstances, getting a debt consolidation loan could fall under the category of good debt if you get a lower interest rate and can pay down your other outstanding loans. Consolidation loans would be viewed as good debt if they put you in a better position than continuing to pay back multiple creditors.

It’s important to note that there are various types of debt consolidation available. Getting the best debt consolidation options will depend on factors like whether or not you have a good credit rating total debt load and assets. Start by looking at The Best Personal Loan Interest Rates, but Loans Canada is a reputable place to start. It functions as a search platform to find the best personal loan to suit your needs and offers loans up to $50,000 and interest rates starting at 5.15%.

In general, if you have a history of bad credit, you may want to avoid pursuing a debt consolidation option because you usually get a favourable interest rate only if you have a good credit rating. If you do have bad credit, and really need a loan, you may want to check out these top bad credit lenders to see if a consolidation loan still makes sense for you. Another option is to get a guarantor who is willing to assume responsibility for your loan if you default on payments. Companies like LendingMate exclusively offer guarantor loans, but they should be considered a last resort because of their higher interest rates.

Fairstone is also a good option: it offers both secured and unsecured loans at lower interest rates than other non-bank lenders, and you can get an instant quote online. If approved, the funds can be deposited into your account in as little as 24 hours. Fairstone qualifies more people with fair to good credit ratings than banks.

Learn more about Fairstone

Should You Consolidate Credit Card Debt?

With their high-interest rates and deceptively small monthly minimum payments, it’s no wonder that credit cards can easily lead to an out of control debt load. It’s not surprising that one of the most common reasons people opt for a consolidation loan is to better handle their credit card debt. There are two ways to consolidate this type of debt: by using a credit card with a balance transfer promo or getting a low-interest credit card.

With one of the best balance transfer credit cards in Canada, you can move debt from other credit cards (usually for a fee of anywhere from 1% to 3% on average) to a new credit card offering a temporary low- or no-interest period. As long as you pay off the balance before the promotional period ends, you could save hundreds, if not thousands, of dollars on interest. Learn more about How to Transfer a Credit Card Balance Wisely.

A low-interest credit card offers a reasonable interest rate as a standard feature, rather than just as a promotional bonus. While not as beneficial as having a zero-interest period, these cards give cardholders more time to pay down debt while taking advantage of a more reasonable interest rate. Note that some of these cards feature annual fees, but the amount you’ll save on interest should easily offset the fee.

The Final Word

Having just gone over the difference between good and bad debt, I do want to add an important caveat. Even good debt is not good if you can’t make payments comfortably. A mortgage is only good debt if you are financially able to make your mortgage payments, as well as keep up with the maintenance and other costs of owning a home. The same can be said for getting a loan to pursue a post-secondary degree. Higher education is no longer a guaranteed path to a lucrative and secure career, so choose wisely.

In the end, assessing debt comes down to a realistic appraisal of whether or not you can handle payments and a clear understanding of whether an item will likely add to your net worth and/or increase in value in the future. If you have questions about your financial future, think about making a financial plan and finding ways to pay down your debt faster.

Article comments

18 comments
susan says:

In your article, good debit vs bad, you mentioned CCA on a car you don’t own. If I am not mistaken, you cannot depreciate a vehicle you don’t own. But, you can write off the lease payments up to a limit? I claim 2 vehicles in my business for the CCA , because I fully own them. Let me know if I have missed something, thanks.

Dolla Thug says:

I definitely understand your argument, but I’m just so anti-debt that the idea of “good debt” just doesn’t convince me. I understand that credit card debt is “worse” debt than student loan debt, but I’m currently in the process of paying off my student loan debt because it’s DEBT. It’s an obligation that I OWE to someone and I can’t WAIT to pay it all off (both federal and private). One day……

young says:

@Dolla Thug- honey, I’m super anti-debt too, but I think it’s a necessary evil (e.g. mortgage debt) unless you win the lottery or something, unfortunately. You’ll pay off your student loan debt in no time, I’m sure. Personal Finance Bloggers are pretty good with their money =) Tracking your net worth or your progress is a great way to do it (and post it online) because it keeps you accountable. That’s what I’m doing and I think it works. =P

Y&T,

There should be a worst debt category for credit cards and loan sharks exclusively!

Good debt can potentially be a loan taken in a low interest rate environment for investment purposes. I guess, the end result would decide in which category to place that debt =)

Cheers!

young says:

@Financial Cents- Thanks for your comment. I do agree that a principle residence can be good debt, but I find that generally a lot of investors do not consider it so, I suppose because a) it doesn’t churn out cash flow and b) it might not necessarily increase in value. I personally would rather categorize a principle as good debt (hey you know me, I’m planning to buy a place here in Vancouver!) but I think I would have gotten a bigger backlash if I categorized it as that. =P

@Little House- that’s a good way to put it- “less toxic”, thanks! Good point re: credit bureau calculations too!

@Barb Friedberg- Yay! thanks for including it in your round up. Really? you can deduct the interest in the states? I need to get my butt down there lol. You can only do that here in Canada if you are using a portion of your home to make money (like rent out the basement suite).

@Mich- Yes, Good Debt Bad Debt Worse Debt! Yeah, credit cards are just ridiculously bad for you (if you don’t pay them off). Thanks for visiting!

Hi- Like the article so much it’s going in my round up tomorrow.. But, I don’t agree with the idea that a home mortgage is “bad” debt. I don’t know if it’s true in Canada, but in the US you can deduct the interest on the loan on your tax return. Nevertheless, I wouldn’t recommend getting a loan that’s too big! Regards, Barb

Little House says:

I think your overall statement is correct, all debt is bad, period. However, if you do have debt, then categorizing what’s less toxic is a good way to decide what to pay off first. I agree that student loan debt is less toxic and car loan debt is more toxic. So paying the car loan off first makes sense. Also, I think that credit bureaus calculate student loan debt differently than revolving debt when calculating a credit score. I haven’t been able to find detailed information on this one, but based on my credit score, they must be factoring in my student loan debt differently. I also agree with FS, leasing a car is silly, even if you can write it off.

Hey Y&T – I don’t know about the principal residence. I would disagree with you there. Yes, a mortgage isn’t great, but everyone needs a roof over their heads and as long as you aren’t counting on your home to rise 5-10% every year in value (unless you’re in Vancouver :), I think a home is considered good debt to have.

Why?

Over time, a home will appreciate in value; maybe not by leaps and bounds – but it will. An asset that will appreciate is considered an investment (and debt to hold it is considered good), an asset that will not appreciate is a liabilitiy (and debt to hold it is bad).

I guess if we could all avoid debt, you wouldn’t be writing this article and I wouldn’t be commenting! 🙂

I always say normalize Interest on debt according to tax advantages then prioritize for borrowing / repayment according to cost.

It does not matter the source or purpose of the debt, all that matters in the after tax interest rate.

so for example, if there is a 0% financing deal when you are buying a car, or a don

young says:

@Dividend Lover- thanks for sharing. That’s exactly what my dad does… he can pay things off, but would rather finance with low interest like 0.9% or 0% for a few months to reap the tax deductions, as well as use that capital for other investments. I like your poem- it summarizes good debt and bad debt in a few sentences.

“…Of course, debt is not good

young says:

@Big Cajun- Hahaha, I definitely added that to the post because I knew I would likely start a riot =) Thanks for visiting Big Cajun!

jesse says:

I think the term “good” and “bad” should really be used not just based on tax efficiency. A mortgage on a primary residence isn’t “bad” because you get capital gains free return at the end, unless you buy into the Smith maneuver scheme.

A better question is why you would take on debt in the first place. If it’s because you can eke a positive return by doing so, even if it’s not tax efficient, I think it’s worth it. It just so happens the government generally agrees with this and offers deductions to foster this behaviour.

young says:

@jesse- Thanks for visiting. Yes I love the idea of free capital gains on a primary residence, but that is provided that you sell the house/home for a profit (please see previous posts on the housing market) =P That would definitely be the ideal situation. Thanks for your input, jesse.

I think you

young says:

@Rebecca- I agree it’s like a catch-22 =) Do you want to get more tax back, or do you want to pay less interest? That is the question. =P

Interesting list, and I gotta disagree with “car lease payments” as being good debt even if you can write it off!

I strongly believe that if you can’t pay cash for a car, you can’t afford it. The 1/10th rule of car buying in effect! Do the lease payments if it complies with the 1/10th rule, but generally, it doesn’t comply if one has car payments.

Best,

Sam

young says:

@Financial Samurai- I remember reading your post on the 1/10th rule a few months ago =) Yeah, some people (realtors etc. and entrepreneurs) I believe get leased cars anyways because they are in the higher tax brackets so they can write off taxes, even though it is very apparent they can pay it off in a lump sum. I agree myself that one should not get a car unless they can pay it off =) I don’t like the idea of adding another payment ontop of the mortgage, that’s like begging to live paycheque to paycheque.