Good Debt vs Bad Debt: What’s The Difference

Debt is an inevitable part of modern finance, but not all debt is created equal. Some debts can pave the way to financial growth, while others can trap you in a cycle of high-interest payments.

Canstar’s eighth-annual Consumer Pulse Report showed that 37% of Australians anticipate being unable to pay at least one regular bill or loan in 2025. The average personal debt has surged to $15,179, marking an increase of $6198 above last year. Among the generations, Gen Z bears the highest average debt, at $23,888, primarily due to HECS-FEE HELP loans.

Understanding the difference between good and bad debt is essential for anyone managing personal and business finances.

We talked to Rojan Paudel, Mortgage Broker at Home Loan Experts to ask for this insights and expertise on good debts and bad debts.

First off, he explained the difference between good debt and bad debt.

“Good debt helps build your future, like a home loan or student loan that increases wealth or earning potential. It’s an investment with long-term benefits. Bad debt, on the other hand, is for things that lose value, like unnecessary credit-card expenses, which drain your finances with no lasting benefits.”

What Is Good Debt?

Good debt is borrowing that positively affects your financial future, such as funding investments or education, and helps you achieve important life goals. These are often investments that appreciate over time or improve your earning potential.

The characteristics of good debt are:

• It provides a positive Return On Investment (ROI)
• It aligns with your long-term financial goals
• It typically has lower interest rates than bad debt.

Examples of Good Debt

Mortgage Loans

A mortgage loan is often considered good debt because it allows individuals to invest in property, which typically appreciates over time. Real estate generally increases in value, providing potential returns when sold, while paying down the mortgage builds equity that can be leveraged for future financial needs. Additionally, investing in property can generate rental income, helping to offset mortgage payments and contribute to cashflow.

As Paudel highlights,

“A home loan is considered good debt because it helps people invest in property, which generally increases in value over time. It’s not just about owning a home, it’s about creating opportunities for a stronger financial future.”

Student Loans

Education leads to higher earning potential. The 2023 Graduate Outcomes Survey reveals that Australian university graduates earn, on average, 15-20% more than non-graduates. The median salary for undergraduates is $71,000, while postgraduate coursework and research graduates earn $96,600 and $100,000, respectively.

Business Loans

Business loans are considered good debt, as they provide funding for growth and operational needs. By borrowing to invest in equipment, expand operations or hire staff, businesses can enhance productivity and increase revenue potential. When managed effectively, these loans can lead to strong returns on investment.

What Is Bad Debt?

Bad debt is the kind that offers no lasting value and often has high interest rates. It is usually used to finance depreciating assets or unnecessary purchases . When individuals take on debt for luxury cars, vacations, or high-interest consumer goods, they may struggle to keep up with repayments. This can lead to missed payments or defaults, negatively affecting credit scores.

The characteristics of bad debt are:

• There’s no opportunity for financial growth or ROI
• Often used for impulsive or non-essential purchases
• High interest rates that quickly accumulate

Examples of Bad Debt

Credit-Card Debt

Credit cards are considered bad debt due to their high interest rates, ranging from 17% to over 20%. This means that balances can quickly accumulate interest, leading to a cycle of debt that is hard to escape. About 1.7 million Australians face increasing credit card debt in 2025, with an average individual debt of $1634, leading to total national credit-card debt of about $2.7 billion.

Payday Loans

Payday loans come with exorbitantly high interest rates and fees. The short repayment terms combined with high costs make it difficult for borrowers to pay off the loan without taking out additional loans, creating a cycle of debt that can be very challenging to break.

Unsecured Personal Loans

Unsecured personal loans can be considered bad debt when used irresponsibly or for non-essential purchases. The lack of collateral means lenders may charge higher interest rates than on secured loans, and missed payments can lead to fees and damage to credit scores.

How Can You Tell If A Debt Is Good Or Bad?

To determine whether a debt is good or bad, Paudel says, you can ask yourself these two key questions:

1. Does it grow in value or generate income?

• A home loan builds wealth if the property appreciates or provides rental income.
• Credit-card debt for luxury items drains resources and provides no financial return.

2. Is it manageable within your budget?

• Wealth-building debt has affordable repayments planned into your budget.
• Burdensome debt often involves high interest and poor financial planning.

What Is Somewhere-In-The-Middle Debt?

Somewhere-in-the-middle debt is a category of debt that doesn’t neatly fit into the traditional classifications of good or bad. It exists in a grey area, where its impact can be either positive or negative, depending on how it’s managed and the individual’s financial situation.

For example, while credit cards are often considered bad debt, they can be beneficial if paid off promptly, avoiding high interest charges. Similarly, Buy Now Pay Later (BNPL) services might seem risky when used for unaffordable items, but they can be useful if managed wisely and without incurring additional fees.

How To Avoid Bad Debt

Managing your finances effectively can help you steer clear of bad debt. Here are some practical strategies to consider:

1. Pay Down High-Interest Debt

Prioritise paying off debts with the highest interest rates, such as credit cards or payday loans. Consolidating your debt into a single loan with a lower interest rate can simplify repayments and reduce the total interest you pay over time.

2. Reduce Unnecessary Spending

Take control of your spending by identifying discretionary expenses like dining out, travel or entertainment. Create a list of non-essential items to cut back on and redirect those funds toward saving or paying off debts.

3. Build an Emergency Buffer

An emergency fund can help you manage unexpected expenses, such as medical bills, without relying on personal loans. Start small and consistently contribute to this fund to provide financial stability during tough times.

4. Be Timely and Consistent

Paying off your debts on time consistently shows that you are financially responsible. Setting up reminders or automating payments can help you stay on track and avoid late fees or penalties.

How To Make The Most Out Of Good Debt

Good debt is a powerful tool if managed wisely. Paudel gave his expert tips on how to maximise the benefits of a home loan:

• Use an offset account to reduce interest while keeping savings accessible.
• Make extra repayments whenever possible to repay the loan faster and save on interest.
• Consider an interest-only loan for investment properties. It can reduce initial repayments, freeing up cashflow to invest or reinvest in the property.
• Regularly review the loan to ensure you get a competitive rate and features when your financial situation changes.
• Use property equity to invest further or improve the home’s value.

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How To Manage Debt Effectively

To manage debt effectively, it is essential to adopt a structured approach.

• Prioritise Your Debt: Decide which debt to pay off first. Focus on high-interest debts like credit cards, as they accumulate balances quickly. Aim to make at least the minimum repayments to avoid late fees.
• Stick To A Budget: Create and follow a budget to manage your expenses and meet your debt obligations. This will help you see how much is due each month and ensure you don’t fall behind on your repayments.
• Open Communication: Maintain open communication with your lender or mortgage broker, especially if you face repayment difficulties. They can help you negotiate better terms or offer hardship programs.

Final Thoughts

Good debt is a tool for building wealth, while bad debt is a financial burden. By understanding the key differences and applying smart debt-management strategies, you can take control of your financial future.

As Paudel puts it,

“It’s all about making debt work for you, not against you.”

One of Paudel’s clients used a guarantor to purchase their first home in Western Australia. Within three years, the property had gained almost $200,000 in equity. The client leveraged this equity to buy their first investment property, setting themselves up for long-term financial success.