How to Tell the Difference Between Good Debt and Bad Debt

Nadav Shemer
Studen Loans and Good Debt
Understand the difference between good and bad debt, and where your student loan fits in the grand scheme of all things debt.

The 5 Ways to Recognize Good Debt

The word debt has negative connotations for most people, but the truth is there are good types of debt and bad types of debt. In the financial world, “good debt” is used to finance something that will increase in value over time. A classic example is a mortgage. You take out a mortgage to buy a house that could be worth twice or three times the purchase price when you pay it off in 20 or 30 years. “Bad debt” includes things like car loans, credit cards, and other things that don’t increase in value over time. Let’s say you take out a high-interest auto loan on a new car. The minute you drive your new car off the lot, its value drops significantly. That’s classic bad debt. Is student debt good debt or bad debt? It can be a bit of both. But as long as you’re using your student loans to boost your future earnings, then it can be considered a good investment and therefore good debt.

Student Loans Can Be Considered Good Debt

Good debt is any type of debt that leads to increased value, which can be achieved in a number of different ways:

1. The debt is backed by an income-producing asset

When you get a mortgage, you secure it against a value-generating asset: your house. Even the lowest mortgages cost around 4% in annual interest fees over a 15-30-year term, not to mention thousands of dollars in closing costs. But as long as property prices keep rising, the cost of your debt is offset by the fact that your house appreciates in value.

When you get a student loan, you are effectively securing your debt against the future earnings you expect to make as a result of having a degree. A recent Georgetown University study found that, on average, college graduates earn $1 million more than non-graduates over their lifetime. A separate study by Pew concluded that the median annual income gap is around $17,500.

Let’s say you take an unsubsidized Stafford loan (a type of direct government student loan) for the maximum permissible amount of $57,500, payable over 10 years. In addition to principal, you’ll pay interest of $13,844.19. The interest is less than the extra pre-tax income you’re likely to make each year as a result of having that degree. True, a degree is no guarantee of a good job or even any job for that matter. But as long as you get a meaningful degree and know what you’re doing once you’re out of college, the likelihood is that your student debt will increase your earning potential to the extent that you can call it “good debt.”

2. The debt is tax-deductible

Under IRS regulations, interest on certain types of debt is tax-deductible. In the case of student loans, taxpayers with gross income of less than $80,000 (or $165,000 if filing with a spouse) can deduct up to $2,500 of student loan interest from their taxes each year. The deduction decreases gradually for people with income of $65,000 to $80,000. Thankfully, the IRS provides a free tool to find out if you qualify for the deduction. In practice, student loan interest deductions can lead to hundreds of dollars of savings on your income tax payments each year, which is another reason student debt can be considered “good debt.”

3. Low interest rates

Of course, the overall value of any debt is determined partly by the interest rate. Even good debt can become bad if you’re paying 20% or 30% interest each year. When it comes to student loans, the good news is that the rates can be very low. In some cases, interest on student loans is not that much higher than the annual inflation rate (which hit 2.8% in June 2018).Loan Type Interest Rate (2017-18) Stafford (Direct Subsidized Loans) 4.45% (paid by government) Stafford (Direct Unsubsidized Loans) 4.45% for undergraduates; 6% for graduate or professional students Perkins 5% PLUS 7%.

Loan Type
Interest Rate (2017-18)
Stafford (Direct Subsidized Loans)
4.45% (paid by government)
Stafford (Direct Unsubsidized Loans)
4.45% for undergrad, 6% for graduate or professional students

4. Loan Forgiveness

The best types of debt are the ones that don’t cost you anything at all. In the case of some public sector, non-profit, and teaching jobs, you may be eligible to have all or a portion of your debt canceled.

  • Income Based Repayment

A government loan forgiveness program based on a percentage of your discretionary income, 10-20%, depending on the plan. After 20-25 years on these plans, remaining payments are forgiven. 

  • Public Service Loan Forgiveness

For employees of: 

  • Government organizations at federal, state, local, or tribal level
  • Non-profit organizations with 501(c)(3) status
  • Other non-profits, if their primary purpose is to provide certain types of public services.
  • Teacher Loan Forgiveness

People who teach full-time for 5 consecutive academic years in a low-income school or educational service agency may be eligible for forgiveness of up to $17,500 of debt.

  • Perkins Loan Cancellation

For teachers:

  • In schools serving low-income students
  • Of infants, toddlers, or children with disabilities
  • Of mathematics, science, foreign languages
  • Other fields where there is a shortage of qualified teachers in the state
  • Special Circumstances

Student debt may also be canceled in the event of the following: 

  • Total or permanent disability
  • Death
  • Bankruptcy (in rare cases)
  • School closure
  • School falsely certifying student’s eligibility for loan
  • Withdrawal from school after receiving loan. 

5. Less Stress in Your Life

Good debt can also include debt that causes you minimum stress and therefore increases your wellbeing. Most people would agree credit card debt is the most common source of stress. Auto-loan debt can also cause stress, given the use of your vehicle as collateral – and its ever-diminishing value. Student debt can be stressful, but if it brings you a good income and job stability then you should be able to easily make your monthly payments without too much worry.


Is student loan debt “good debt” or “bad debt”? The answer is that it could be either, but as long as it puts you on the path to a decent-paying job in the years after college – it is overwhelmingly good.In the event you find yourself unable to pay off your debts and ineligible for loan forgiveness, you can always apply for student loan consolidation or refinancing. You can consolidate your federal government loans with a Direct Consolidation Loan. Or you can refinance government or private loans from private lenders, turning multiple student loans into one monthly payment. Assuming your credit improves after graduation, you should be able to compare lenders and refinance your debts with a lower interest rate.

Nadav Shemer
Nadav Shemer specializes in business, tech, and energy, with a background in financial journalism, hi-tech and startups. He enjoys writing about the latest innovations in financial services and products.