Good debt vs bad debt: when borrowing makes sense and when it does not

Debt has a bad reputation, and in many cases it deserves it. But there are situations where borrowing is the smartest decision you can make. The difference lies in what that money finances and at what cost.

A mortgage to buy a home that will appreciate is a classic example of good debt. A student loan that gives you access to a better-paying job is another. Or debt to start a business with real potential. In all these cases, the asset you create is worth more than the loan cost over the long term.

The key is always the same: if the expected return on the asset exceeds the loan interest rate, the debt may make sense. If not, you are paying for something that will not generate that value for you.

Bad debt is the kind that finances fast-depreciating consumption. The TV on instalments at 18%, the holiday paid by card that takes two years to clear, or the car financed at 9% when that same money in the market would perform better. Those expenses are not forbidden: it is paying for them with expensive debt that has a real cost many people do not calculate.

The most common problem is the snowball effect. When interest accumulates faster than you can repay, the debt grows even while you are paying it. With credit cards at 20-25%, this is especially dangerous because the minimum payment barely covers the interest.

The car is the perfect grey area example. You need one for work, but it depreciates the moment you drive off the lot. If you finance it at 6% and the car is essential to generate income, it could be considered reasonable. If you finance it at 10% for a bigger model than you need, it becomes bad debt.

The same applies to education. A €15,000 master's degree on credit makes sense if the salary increase recovers it in 3-4 years. If you do it because it looks good on a CV but the market does not value it, it can become a burden.

The question that always works is: if you had the cash, would you still buy it? If the answer is no, you are probably using debt to buy something you deep down know you cannot really afford yet.