Good Debt vs. Bad Debt: A Framework for Strategic Leverage
This is a pillar article in the Wealth vertical. Read the flagship: Behavioral Finance for Real Life
Most People Get Debt Backwards
Personal finance gurus love to shout “all debt is bad” or “debt is slavery.” Meanwhile, real estate investors and business owners use debt to build multi-million dollar portfolios.
So which is it?
The answer: it depends entirely on what you’re borrowing for and at what cost.
A 3% mortgage to buy a home you can afford while investing the difference at 8% is very different from a 24% credit card balance funding lifestyle inflation. One compounds your wealth. The other destroys it.
Yet most people treat all debt the same—either avoiding it religiously or accumulating it thoughtlessly. Neither extreme works. The former leaves money on the table. The latter leads to financial fragility.
The framework: Debt is a tool. Like any tool, it can build or destroy depending on how you use it. The key is understanding when leverage accelerates your goals and when it sabotages them.
This article complements the Behavioral Finance flagship by addressing the specific behavioral and mathematical questions around debt. While behavioral finance teaches you to avoid lifestyle inflation and invest wisely, this guide teaches you when borrowing makes strategic sense.
The Seven Principles of Strategic Debt Management
1. The Core Question: Does This Debt Build or Drain Assets?
The fundamental distinction between good and bad debt comes down to one question:
Is this debt financing an appreciating asset, a cash-flowing investment, or future earning power? Or is it financing consumption?
Good debt characteristics:
- Finances assets that appreciate or generate income
- Interest rate is lower than expected returns
- Enhances future earning power
- Has a clear payoff plan
Bad debt characteristics:
- Finances depreciating assets or consumption
- High interest rate (typically >8%)
- No plan for repayment
- Reduces future financial flexibility
Examples of potentially good debt:
Student loans (context-dependent)
- Medical school → $300k debt → $400k+ annual income = good leverage
- Liberal arts degree → $100k debt → $45k income = wealth destroyer
- Computer science bootcamp → $15k debt → $95k income = excellent leverage
Mortgages (context-dependent)
- 3% mortgage on a home you can afford while investing aggressively = good leverage
- 6% mortgage with 5% down on a house you can barely afford = financial fragility
Business loans
- Equipment loan at 5% that increases revenue by 20% = good leverage
- Line of credit at 12% to cover payroll because sales are slow = dangerous
Examples of almost always bad debt:
Credit card debt
- 18-28% APR compounds faster than almost any investment returns
- Typically funds consumption, not assets
Car loans (usually)
- 6-10% interest on a rapidly depreciating asset
- Ties up cash flow for years
Payday loans
- 300-400% APR (not a typo)
- Predatory and wealth-destroying
The decision framework:
Before taking on debt, ask:
- What am I buying with this money?
- Will it appreciate, generate income, or increase my earning power?
- Is the interest rate lower than my expected return on investments?
- Can I afford the monthly payments even if my income drops 20%?
- Do I have a clear payoff plan?
If you can’t answer yes to questions 1-2 and at least 3 of questions 3-5, it’s probably bad debt.
2. The Interest Rate Decision Tree
Not all debt at the same interest rate is equal, but interest rate is the primary factor.
The hierarchy:
<3% APR: Almost always keep it
- Inflation often runs 2-3% annually
- You’re being paid (in real terms) to borrow
- Examples: Federal student loans, some mortgages (2020-2021), subsidized business loans
3-5% APR: Context-dependent
- Cheaper than historical stock market returns (~10% nominal, ~7% real)
- Mathematical case for investing instead of paying off
- Emotional/behavioral factors matter here
5-8% APR: Lean toward paying off
- Roughly matches stock market real returns
- Guaranteed return vs. market volatility
- Most people should pay these off aggressively
>8% APR: Always pay off aggressively
- Higher than most investment returns
- Compounds against you fast
- Examples: most credit cards, personal loans, car loans
>15% APR: Financial emergency
- Drop everything else
- Pay these off immediately
- Avoid taking on more
Example decision:
You have $10k cash. You also have:
- Federal student loans at 3.5% ($20k balance)
- Car loan at 7% ($15k balance)
- Credit card at 19% ($5k balance)
Priority order:
- Pay off credit card completely ($5k)
- Put $5k toward car loan
- Keep the remaining student loan debt and invest extra cash
Why: The credit card costs you 19% guaranteed. The car loan at 7% is borderline but costs more than most safe returns. The student loans at 3.5% are cheaper than inflation—keep them and invest instead.
3. Student Loans: When Education Debt Pays Off
Student loans are the most debated category because they’re often the first major debt people take on, and the outcomes vary wildly.
The brutal math:
Education debt only makes sense if:
- Debt-to-starting-salary ratio < 1.0
- Example: $50k debt → $50k+ starting salary = manageable
- Example: $150k debt → $45k starting salary = financial disaster
High-ROI degrees (typically worth borrowing for):
- Medicine (despite high debt, income is very high)
- Engineering (strong salary-to-debt ratio)
- Computer science (high starting salaries, growing field)
- Nursing (stable, well-paying, high demand)
- Certain trades (electrician, plumber—often no debt at all)
Low-ROI degrees (rarely worth significant debt):
- Most liberal arts unless going to top-tier school with strong alumni networks
- Fine arts (pursue passion, but minimize debt)
- General business degrees from mid-tier schools
The opportunity cost insight:
$100k in student loans at 6% means $10k+ annually in loan payments for 10+ years. That’s $10k that can’t be invested. Over 30 years, that lost investment opportunity costs you $300k+ in wealth building due to lost compounding.
Strategic approaches:
If you already have student loans:
Federal loans (typically 4-6% APR):
- Check if you qualify for income-driven repayment (IDR)
- Consider Public Service Loan Forgiveness (PSLF) if eligible
- If interest rate < 5%, invest extra money instead of paying off early
- If interest rate > 6%, pay off aggressively
Private loans (typically 6-12% APR):
- Refinance if possible (check for better rates)
- Prioritize these over federal loans
- Pay off aggressively (higher priority than investing)
If you’re considering taking on student loans:
- Calculate total debt at graduation
- Research median starting salary for your degree
- Apply the debt-to-salary ratio rule
- If ratio > 1.5, reconsider the program or school
The Career Capital connection: Education debt only makes sense if it builds career capital. A bootcamp that costs $15k but gets you a $95k job builds career capital efficiently. A $200k degree that leads to a $55k job does not.
4. Mortgages: The Most Common “Good Debt” Trap
A mortgage is typically the largest debt most people will ever take on. It can be wealth-building leverage or a financial anchor.
When a mortgage is good debt:
- Interest rate < 5%
- Monthly payment (PITI: principal, interest, taxes, insurance) ≤ 25% of gross income
- 20%+ down payment (avoid PMI)
- Plan to stay 5+ years
- You’re investing aggressively in parallel
When a mortgage is bad debt:
- Interest rate > 6%
- Monthly payment > 30% of gross income
- < 10% down payment
- Stretching to buy more house than you need
- Not investing because “the house is an investment”
The math that changes everything:
A house is not an investment in the traditional sense. It doesn’t generate cash flow (you live in it). It appreciates roughly with inflation (3-4% historically, excluding 2020-2022 anomaly). After maintenance, taxes, and insurance, real returns are near zero.
What matters: The house provides shelter. The mortgage provides leverage if used correctly.
Scenario A: Rent and invest aggressively
- Rent: $2,000/month ($24k/year)
- Invest: $1,500/month ($18k/year)
- After 20 years: ~$900k invested portfolio (assuming 8% returns)
Scenario B: Buy with mortgage and invest moderately
- Mortgage + taxes + maintenance: $3,000/month
- Invest: $500/month ($6k/year)
- After 20 years: House paid off (~$600k value) + $300k invested portfolio = $900k total
The outcome is similar. The real question is behavior. Most people won’t actually invest the difference if they rent. So buying can be forced savings. But it’s not automatically wealth-building.
The optimal strategy:
Buy a house you can comfortably afford (≤25% of income) with a low interest rate (<5%), and invest aggressively in parallel. This captures the forced savings benefit of homeownership while not sacrificing investment compounding.
The 15 vs. 30-year mortgage question:
If interest rate < 4%:
- Take the 30-year mortgage
- Invest the difference between 15-year and 30-year payments
- Your investments will likely outpace the interest cost
If interest rate > 5%:
- Consider the 15-year mortgage
- You’re locking in a guaranteed 5%+ return by paying it off faster
Pay-off vs. invest decision:
If you have extra cash, should you pay down your mortgage or invest?
Rule of thumb:
- Mortgage rate < 4%: Invest extra cash
- Mortgage rate 4-5%: Toss-up (depends on risk tolerance)
- Mortgage rate > 5%: Pay off mortgage aggressively
5. Consumer Debt: The Wealth Killer
Credit cards, personal loans, and car loans are where most people destroy their financial futures.
Why consumer debt is so dangerous:
- High interest rates (15-25%+): Compounds faster than any realistic investment returns
- Finances depreciating assets or consumption: You’re paying interest on things that lose value
- Behavioral trap: Easy to accumulate, hard to pay off, creates debt spiral
Credit card debt:
The average American carries $6,000+ in credit card debt at 20%+ APR. That’s $1,200+ in annual interest. Over 10 years, if you just pay minimums, you’ll pay $20k+ in interest on $6k in spending.
The only acceptable use of credit cards:
- Pay off the full balance every month
- Use for rewards/cash back (if you have discipline)
- Never carry a balance
If you can’t do this, cut up the cards and use debit or cash until you build discipline.
Car loans:
Cars depreciate 20-30% in the first year, 50%+ in the first 5 years. Borrowing money at 6-10% to buy a depreciating asset is wealth destruction.
The alternatives:
- Buy used with cash (3-5 years old = best value)
- If you must finance, keep loan < 3 years and payment < 10% of income
- Better yet: drive a 10-year-old reliable car and invest the difference
Example math:
Scenario A: Finance new car
- $40k new car
- $600/month payment for 6 years
- Total cost: $43k (interest included)
- Car worth $15k after 6 years
Scenario B: Buy used, invest difference
- $15k used car (3 years old, cash)
- Invest $600/month for 6 years
- Total invested: $43k + returns = ~$52k
- Car worth $8k after 6 years
- Net position: $60k ($52k invested + $8k car)
The gap: $45k difference in wealth over 6 years from one decision.
Personal loans:
Typically 8-15% APR. Almost always a sign of poor financial planning or emergency.
If you have one:
- Pay off as fast as possible
- Cut expenses to free up cash
- Build an emergency fund so you never need one again
If you’re considering one:
- Ask: “Why don’t I have cash for this?”
- Fix the underlying behavior problem first
- Avoid unless it’s a true emergency
6. Business Debt: When Leverage Actually Builds Wealth
Business debt is fundamentally different from consumer debt because it (ideally) generates cash flow.
When business debt makes sense:
Equipment/inventory loans:
- You’re buying assets that generate revenue
- Example: $50k equipment loan → increases capacity → $100k additional annual revenue
- ROI is clearly positive
Real estate investment loans:
- Rental property cash flows enough to cover mortgage + expenses
- Leverage multiplies returns on appreciation
- Example: $50k down, $200k mortgage → $250k property appreciating at 4% = $10k annual appreciation on $50k invested = 20% return
Growth capital:
- Borrowing to scale a profitable business
- Clear path to ROI
- Example: $100k loan to hire salespeople who each generate $300k in revenue
When business debt is dangerous:
Covering operating expenses:
- If you need debt to make payroll or pay rent, your business model is broken
- Fix the model, don’t add debt
Speculative ventures:
- Borrowing for unproven business ideas
- High risk of losing everything
Overly aggressive leverage:
- Borrowing so much that one bad month bankrupts you
- Real estate investors in 2008 learned this painfully
The leverage multiplication insight:
Real estate example:
- Buy $250k property with $50k down (80% LTV)
- Property appreciates 4% annually = $10k
- Your return on invested capital: $10k / $50k = 20%
- Without leverage: $250k cash → 4% = $10k on $250k = 4%
Leverage multiplies returns (and losses). Use it when you’re confident in the asset and can weather downturns.
7. The Debt Payoff Framework: Avalanche vs. Snowball
When you have multiple debts, prioritization matters.
Two main strategies:
Debt Avalanche (mathematically optimal):
- Pay minimums on everything
- Put all extra money toward highest interest rate debt
- Once that’s gone, move to next highest
- Saves the most money in interest
Example:
- Credit card at 22% ($5k)
- Car loan at 8% ($12k)
- Student loan at 4% ($25k)
Pay off in that order.
Debt Snowball (psychologically easier):
- Pay minimums on everything
- Put all extra money toward smallest balance
- Once that’s gone, move to next smallest
- Creates psychological wins faster
Example:
- Credit card at 22% ($5k)
- Car loan at 8% ($12k)
- Student loan at 4% ($25k)
Same order in this example, but if student loan was $3k, you’d pay it first despite low interest rate.
Which to choose:
Use Avalanche if:
- You’re motivated by math and long-term optimization
- Interest rate differences are significant (>5% gaps)
- You can stay disciplined without quick wins
Use Snowball if:
- You need psychological wins to stay motivated
- Balance sizes vary significantly
- You’ve struggled with debt payoff before
The hybrid approach (recommended for most):
- Pay off all debt >15% APR immediately (emergency tier)
- Use snowball for debts 8-15% (psychological momentum)
- Use avalanche for debts <8% (mathematical optimization)
- Keep debt <4% and invest aggressively instead
How Debt Strategy Compounds Across Other Verticals
Debt → Health
Bad debt creates chronic stress. Money problems are the #1 source of relationship conflict and mental health issues. High-interest debt traps you in a stress cycle.
Good debt (used strategically) reduces stress. A mortgage at 3% that locks in housing costs provides stability. Student loans that lead to a high-paying career create financial security.
Debt → Relationships
Consumer debt destroys relationships. Financial stress causes more divorces than infidelity. Credit card debt from lifestyle inflation creates resentment and conflict.
Strategic debt discussion builds alignment. Couples who discuss debt strategy explicitly (when to use leverage, when to avoid it) build financial partnership. See Relationships for more.
Debt → Career Capital
Student loans can build career capital or destroy it. The key is the debt-to-income ratio and the skills you’re acquiring. As covered in Career Capital, education is only valuable if it increases earning power more than the debt costs.
Debt limits career optionality. High debt loads force you to take high-paying jobs you might hate. Financial independence (covered in Behavioral Finance) requires minimizing bad debt.
Debt → Purpose
Bad debt traps you in work you don’t care about. If you owe $2,000/month in debt payments, you can’t pursue lower-paying meaningful work or take career risks.
Strategic debt can enable purpose. A mortgage on a home near aging parents, a business loan to start your dream company, or education debt that leads to meaningful work can align with purpose.
What Most Debt Advice Gets Wrong
Mistake 1: “All Debt Is Bad”
Dave Ramsey’s “debt-free” philosophy (Ramsey, 2013) helps people escape consumer debt traps, but it leaves money on the table. A 3% mortgage while investing at 8% is mathematically superior to paying off the mortgage early.
Better advice: Distinguish between wealth-destroying debt (>8% APR, consumption) and wealth-building debt (<4% APR, assets or income-generating).
Mistake 2: “Your House Is Your Best Investment”
Houses are shelter, not investments. They appreciate roughly with inflation after expenses. Real wealth building happens through stocks, businesses, and income-generating real estate (rentals).
Better advice: Buy a home you can comfortably afford, but don’t stop investing in actual assets.
Mistake 3: “Always Pay Off Debt Before Investing”
This ignores interest rate math. Paying off a 3% mortgage instead of investing at 8% costs you 5% annually. Over 30 years, that’s hundreds of thousands in lost wealth.
Better advice: Use the interest rate decision tree (Section 2). Low-interest debt (<4%) should often be kept while you invest.
Mistake 4: “Student Loans Are Always Worth It”
The debt-to-income ratio matters more than the prestige of the school. A $150k degree leading to a $50k job is financial disaster, regardless of how “good” the education was.
Better advice: Calculate expected starting salary and ensure debt stays below 1x that amount.
Mistake 5: “Carry a Credit Card Balance to Build Credit”
This is a myth spread by people who profit from your interest payments. You build credit by having credit accounts and paying them off in full every month, not by carrying balances.
Better advice: Use credit cards for rewards and convenience, but pay them off completely every billing cycle.
Your Next Steps
Audit Your Current Debt
List all debts with:
- Balance
- Interest rate
- Monthly payment
- Purpose (what you bought)
Calculate:
- Total debt
- Weighted average interest rate
- Monthly debt payments as % of income
Red flags:
- Any debt >15% APR
- Debt payments >30% of gross income
- Increasing credit card balances month-over-month
Apply the Decision Framework
For each debt, ask:
- Is this financing an asset, income source, or earning power? Or consumption?
- Is the interest rate above or below expected investment returns?
- Can I afford this payment if my income drops 20%?
Build Your Payoff Plan
Using the Avalanche/Snowball framework:
- List all debts >8% APR
- Prioritize these for aggressive payoff
- Maintain minimums on debts <5% APR
- Invest extra cash instead of paying off low-interest debt
Create Your Debt Rules
Write down your personal rules:
- “I never carry credit card balances”
- “I only take on debt if interest rate < 5% and it finances an asset”
- “My mortgage + taxes will never exceed 25% of gross income”
- “I’ll research debt-to-income ratios before any education borrowing”
Set Up Automated Payments
Automate minimum payments on all debts to avoid late fees and credit damage. Manually direct extra payments to priority debts.
Disclaimer: This article is for educational purposes only and is not investment, tax, or financial advice. Do your own research or consult a qualified professional before making financial decisions.
This is a pillar article in the Wealth vertical. Start with the flagship: Behavioral Finance for Real Life. Explore the full framework: 4-Vertical Life Portfolio. Other wealth articles: Career Capital. Other verticals: Health, Relationships, Purpose.