Good Debt Versus Bad Debt, and Which One are Student Loans?

You may know of someone who completely tries to avoid using debt at all costs. They probably swear off of credit cards, pay for everything in cash, and may not even have a bank account. This mindset isn’t completly uncommon, but results from a lack of understanding the difference between “good debt” and “bad debt.” 

Good debt and bad debt can be differentiated in many different ways, but generally, good debt can be defined as “low-interest debt that helps you increase your income or net worth,” and bad debt does not increase your income or net worth.

Some examples of good debt can be a mortgage on a property, a car loan, or a small business loan. Bad debt is usually credit card debt, personal loans for your own entertainment/enjoyment, and payday loans. For the purpose of this discussion however, I would like to include car loans as bad debt, if you’re using a car loan to purchase something more than you need to get to work and increase your income. A $5,000 car loan on a used vehicle that you drive all the time isn’t bad debt. A $35,000 car loan on a new, fully loaded, sports car is not good debt.

So now that you have a basic understanding of how good and bad debt are defined, where do student loans fall? Similar to the other loans in this article, it really depends on the specific situation. Most people would classify student loans as good debt, but I would add a small qualification to that. I would classify good student loan debt as a total balance that does not exceed your expected annual income after graduation. Inversely bad student loan debt is a balance that does exceed your expected annual salary. For example, if you amass $40,000 in student loan debt, but have a salary of $60,000 per year, you shouldn’t have too much trouble paying back your debt over a ten year period (~$440/month). However, if you rack up $140,000 in debt and have an income of $60,000 per year, your payment jumps to over $1,500 per month at the ten year rate. That’s almost 40% of your monthly take home! In the second scenario, you’d be much better off pursuing either the public or standard student loan forgiveness routes. There’s nothing wrong with student loan forgiveness, and many students, myself included, would be completely lost without it. However, when breaking down the strict financial soundness of a loan, the best return on investment is still maintaining a balance that is lower than your annual income.

So there it is. If your a new college student, or a high school student looking at colleges and professions, keep this in mind. If your further along in your college career, or already in the workforce, and your annual income is much lower than your student loan balance, then it’s probably time to start looking at alternative options. Good luck, and as always, please comment below with thoughts or questions!