Good Debt and Bad Debt: Judging What a Loan Buys

"Good debt" and "bad debt" are popular labels, but they hide the real question: what does this particular loan buy, and what will it cost compared with what it gives back? A mortgage can be a sensible way to own a home or a strain that leaves no room for anything else. A student loan can raise lifetime earnings or follow someone for decades without the degree paying off. This chapter replaces the labels with four questions you can ask of any debt, works through a car loan and a mortgage, and explains when the tax deductions people cite actually help.

Four questions to ask of any debt

1. What does it pay for, and will that last longer than the loan? Borrowing for something that keeps or grows its value, or that raises your income, can leave you better off even after interest: a home you would otherwise rent, training that leads to a better-paid job, equipment for a business. Borrowing for something used up quickly, such as a holiday, meals or most clothes, leaves the debt behind long after the benefit is gone. Cars sit in between: they lose value every year, but for many people they are what makes earning possible.

2. Is the rate lower than what the money could reasonably earn, or save, elsewhere? Paying down a loan earns a guaranteed return equal to its rate. A credit card at a rate in the twenties beats almost any investment you could make with the same money. A low fixed-rate loan may not; extra money might do more invested. The pay off debt or invest calculator runs that comparison.

3. Does the term match the life of what it buys? A loan that lasts longer than the thing it paid for means paying for something you no longer have. A long car loan can leave you owing more than the car is worth for years, which becomes a problem if it is written off or you need to sell.

4. What happens if your income drops? A payment that is comfortable today can be crushing after a job loss. Fixed payments, variable rates, secured loans that put a home at risk, and the protections a loan does or does not offer all matter here. Lenders look at your debt-to-income ratio, your monthly debt payments divided by gross monthly income, for the same reason.

A debt that passes all four is usually a reasonable tool. A debt that fails the first two is usually a cost to minimise and clear.

The term is part of the price: a car loan

Car loans have stretched over the years, and longer terms lower the payment, which is how they are sold. The total cost tells a different story.

Over 6 years the payment is $519 a month and the interest is $7,347. Over 4 years the payment rises to $725, but the interest falls to $4,818. If the higher payment does not fit, the more effective lever is usually a cheaper car or a larger down payment, not a longer loan. The true cost of a car calculator adds depreciation, insurance and running costs to the loan.

The term is part of the price: a mortgage

A mortgage is the classic example of debt that can build wealth, because it buys an asset you would otherwise pay for in rent, and each payment adds to your equity. Even so, the choice of term changes the cost enormously. Fifteen-year loans usually carry a somewhat lower rate than thirty-year loans.

The 30-year loan costs $1,896 a month and $382,633 in interest over its life. The 15-year loan costs $2,532 a month and $155,683 in interest. Neither is automatically better. The longer loan keeps the required payment lower, which protects you if income falls, and leaves room to save or invest; you can always pay extra. The shorter loan forces faster equity and costs far less interest. The home affordability calculator shows what payment your income supports, and the pay off mortgage or invest calculator compares extra payments with investing.

A home also carries costs that a loan comparison leaves out: property tax, insurance, maintenance and the cost of buying and selling. Rising prices are not guaranteed in any given place or period.

Education debt: judge it by what it leads to

Borrowing for education can be among the best investments a person makes, or among the hardest debts to carry. What decides it is mostly the field, whether you finish, and how much you borrow relative to the earnings the program leads to. Programs publish their costs, and the U.S. Department of Education's College Scorecard shows typical earnings and debt by school and field of study. A rough check before borrowing: compare the total you would owe with the first-year salary in that field, and estimate the payment on the student loan repayment plan calculator before you sign.

Federal student loans also carry protections, covered in chapter 8, that make them less risky than their balance suggests. Private education loans generally do not.

Tax breaks: smaller than people think

Interest on some debts is deductible, which lowers the effective rate, but less often than many assume.

• Mortgage interest is deductible only if you itemize deductions, and only on home loans of up to $750,000 used to buy, build or substantially improve your home. Itemizing helps only when your total itemized deductions exceed the standard deduction, which for 2026 is $16,100 for a single filer and $32,200 for a married couple filing jointly. Many homeowners take the standard deduction, so their mortgage interest saves them no tax at all.
• Student loan interest can be deducted up to $2,500 a year without itemizing, but the deduction phases out at higher incomes, and it lowers your taxable income, not your tax dollar for dollar.
• Business debt interest is generally a business expense, subject to its own limits.
• Credit card, car and personal loan interest for personal use is not deductible. The exception is new: for 2025 through 2028, interest on a loan for a new passenger vehicle assembled in the United States and bought for personal use can be deducted up to a yearly cap, phasing out at higher incomes. The new tax deductions calculator shows what it is worth; check that the vehicle qualifies before counting on it.

A deduction reduces the cost of interest by roughly your marginal tax rate, at most. It is a reason to prefer one kind of borrowing over another, not a reason to borrow.