Good Debt Vs Bad Debt Types

Debt can be a tricky thing to navigate. As many of us have experienced firsthand, it’s much easier to get into debt than out of it! However, the idea of “debt” is not a monolith—there’s nuance to it because there are different types of debt.

These types of debt can affect your finances in different ways. (For one, not all kinds of debt are bad!)

Knowing the different sorts of debt and how to manage them can help you make better decisions about your finances.

In this article, we’ll discuss the different sorts of debt and highlight the ones you should be careful to avoid. We’ll also include examples that work for you vs against you.

Types of debt: An overview

Before we jump into specific examples of debt, let’s go over two big factors that can divide debt types into different categories.

Secured vs unsecured debt

On a high level, there are two main types of debt: secured and unsecured.

Secured debt

Secured debt is a type of loan that is secured by collateral, such as a house or car loan. If the person who borrowed the money is not able to make payments on the loan, then the lender can take possession of the collateral.

Unsecured debt

Unsecured debt is a type of loan that is not backed by collateral. Since the lender has no way to guarantee repayment, they typically charge more interest or have stricter loan requirements.

Unsecured debt can include credit cards, personal loans, student loans, medical bills, and more.

Revolving vs installment debt

Another distinction would be between revolving and installment debt. These can both also fall under the umbrella of secured or unsecured.

Revolving debt

Revolving debt allows you to borrow, repay, and re-borrow money up to a certain limit. Credit cards are a very common form of revolving debt.

The interest rate on revolving debt will vary depending on the type of loan and your creditworthiness.

Installment debt

Installment debt is a type of loan where borrowers make fixed payments over a period of time. Most of the examples on this list will be installment loans; they're more common than revolving ones.

The main differences here lie in how repayment is structured. With revolving debt, you use and repay it as needed.

With installment debt, you make fixed payments over a specified period of time. Additionally, revolving debt typically has a higher interest rate than installment debt.

Now that we’ve covered the basics, let’s break down the different secured and unsecured subtypes in each category!

5 Secured debt types

For debt to be considered “secured,” you must put up some form of collateral. In many cases, the item you’re financing will serve as its own collateral. For instance, if you stop paying your auto loan, the car could be repossessed.

It is generally easier to be approved for a secured loan since the lender can recoup some of their losses if the borrower defaults. Here are five examples of debt that count as secured!

1. Mortgages

This is a type of secured installment debt that is used to finance the buying of a property, like a personal home. The property itself is the collateral for the loan.

If you stop making payments, the lender could ultimately foreclose on the house. A mortgage loan is typically paid each month over a period of 15 to 30 years.

When you’re buying a home, you’ll put a certain amount down initially (the “down payment”). Then, you'll apply for a mortgage to cover the rest.

Interest rate and principal

The interest rate on your mortgage will be based on your credit history, the amount of the loan, and the length of the loan term.

Like with most loans, your monthly payments will be a mix of principal and interest. As you pay off the principal, you’ll owe less interest with each payment, meaning that more of your money will be applied to the principal as time goes on.

In turn, you’ll own a bigger and bigger percentage of the house, called your home equity.

Good debt or bad debt? Mortgage debt is usually considered one of the best kinds of debt. However, it does still depend on the situation.

On one hand, taking out a mortgage allows you to purchase a home, providing stability and a place to build your foundation for a sound financial future (along with equity). On the other hand, you want to be careful that you’re not biting off more than you can chew.

A large mortgage loan plus other home expenses could end up making you “house poor”!

2. Auto loans

If you’re looking to buy a vehicle like a car or truck, you have two options. The first is to save up for the vehicle and pay the full amount in cash.

The second is to take out an auto loan. These are installment loans where you’ll have a fixed payment over a specified period of time. The vehicle serves as collateral for its own loan, so it can be repossessed in the event of nonpayment.

What you need to get an auto loan

In order to get an auto loan, you will typically need to provide proof of income, a credit score, and a down payment on the vehicle. The terms of your loan will vary depending on the lender and your credit/finances.

Good debt or bad debt? This one can go either way. Instead of taking on a hefty amount of debt for the newest and most expensive cars, it’s usually best to focus on more modest, affordable options.

Otherwise, you might find yourself struggling to make payments and wondering how to get out of a car loan!

3. Equipment loans

If you’re a small business owner or an entrepreneur, you might find yourself considering various sorts of debt to finance tools and machinery needed to run a business. That’s what equipment loans are for!

Just like the other two secured types above, the equipment you’re buying serves as its own collateral.

What you might use an equipment loan for

Equipment loans are typically used to purchase items such as computers, software, machinery, and other things that may be necessary for a business to operate.

You can also use these types of debt to finance things you need for growth and expansion. Equipment loans are paid back in regular installments.

Good debt or bad debt? Overall, equipment loans can be beneficial for businesses and entrepreneurs. However, make sure you’ve crunched the numbers and factored them into your business plan.

This equipment should help you achieve your small business goals and make more money! But taking on too much debt too fast could put your business at risk.

4. Home equity loans

This type of loan, also called a "second mortgage", lets homeowners borrow money by using their home's equity as collateral.

Remember, equity is the portion of the home's value that belongs to the owner. Equity value can also increase as the property value appreciates.

How to use the money from a home equity loan

People use home equity loans for a variety of reasons. You might want it for improvements, debt consolidation, education expenses, or major life events such as a wedding or medical bills.

Homeowners may also use a home equity loan to finance the buying of a second home or investment property.

A homeowner can apply for a home equity loan through a bank or lender. They will determine the amount of equity available in the home and the homeowner's ability to repay the loan.

If approved, the homeowner will receive a lump sum of money and will be required to make monthly payments on the loan, which typically have fixed interest rates and repayment terms.

Good debt or bad debt? This depends on how you use it. If you want the money to make improvements that increase the value of the property, that could be useful debt.

The same goes for leveraging your home’s value to buy another property that will make you money.

Or, if you’re using the loan money to pay off higher-interest debt like credit cards, it could be a smart financial decision to consolidate that debt at a lower interest rate.

However, the flip side is that home equity loans are examples of debt with very high stakes. If you can’t make the payments, you might lose your home. So, proceed with caution!

5. Secured line of credit

If you don’t have a great credit score, you might struggle to get traditional unsecured lines of credit (e.g. most credit cards). That’s where secured lines of credit come in.

You’ll put up collateral to secure the loan, like money in your savings account, a vehicle, or other assets.

How it affects credit scores

A line of credit is revolving debt. That means you can access funds as needed, repay the debt, then use it again in the future. A huge perk is that making payments on time will help improve your credit score!

Good debt or bad debt? The main benefit of a secured line of credit is to help you build your credit.

Of course, as with any secured loan, you risk losing your collateral (and tanking your credit further) if you’re unable to make payments.

5 Unsecured debt types

Now, let’s turn to the various unsecured types of debt. Since unsecured types don’t involve collateral, you won’t have to worry about things like losing your house if things go south.

However, this type of debt is typically more expensive than secured debt since it's riskier for the lender. Let’s check out five different unsecured sorts of debt.

1. Credit cards

Chances are, this is one type of debt you’ve already heard of! When you choose to use a credit card to purchase goods and services, you are essentially borrowing money from the issuer of the card, who in turn charges interest for the privilege.

Pros and cons of credit cards

These interest rates are typically quite high. If you aren't careful, credit card debt can quickly start compounding and spiraling out of control.

Of course, it is possible to use credit cards wisely. If you pay them off in full each month, you’ll never pay a cent in interest or late fees.

Credit cards can also help you earn travel miles or cash back! With discipline and consistency, you can make credit cards work for you instead of against you.

Good debt or bad debt? Credit card debt is an example of bad debt. If you’re in credit card debt now, use these tips to pay it off quickly.

Then, figure out how to use credit cards in a responsible way for future purchases.

2. Student loans

Higher education typically comes with an intimidating price tag. If you’re looking to launch a new career with the help of a bachelor’s or post-graduate degree, you may have to take on some student loan debt to make it happen.

This is among the most common examples of debt for young people.

Interest rates and repayment

Student loan debt allows students to borrow money to cover their tuition and other college costs. Luckily, interest rates are typically lower for student loans than for other types of unsecured debt.

Repayment options vary, but typically, students must begin repayment of their loan once they leave school. In some cases, students may qualify for loan forgiveness programs if they work for a qualifying employer.

Good debt or bad debt? Student loan debt is generally considered to be “good” debt. After all, it's an investment in yourself and your future.

However, make sure that you’re taking a clear-eyed look at your future career and salary prospects to make sure you’ll get a good return on your investment! Check out these tips and resources on managing student loans—or this advice on how to avoid them.

3. Medical debts

For many people, medical debt comes as an unfortunate surprise. You may be uninsured or underinsured when you’re suddenly faced with an accident, emergency, or diagnosis that requires treatment.

If you can’t afford the out-of-pocket expense, you may have no choice but to take on medical debt.

Payment options

Most hospitals will help patients navigate payment options. You can typically apply for hospital financing through the hospital's billing department or through a third-party financing company that the hospital partners with.

The details of medical loans will vary by hospital. They do often come with low (or no) interest to help make treatments more financially accessible.

Sometimes, you can also negotiate with the hospital for a lower bill.

Good debt or bad debt? Medical debt can be both good and bad debt. On one hand, it can be beneficial for those who are facing a medical emergency or need to pay for treatments for a chronic condition.

On the other hand, medical debt can also turn into a source of financial hardship. Ultimately, it’s important to make sure you always have medical insurance, but sometimes you just can't avoid taking on this kind of debt.

4. Payday loans

Payday loans are ultra-short-term loans that borrowers use to get immediate access to money. They're based on the idea of “making it until payday.”

Repayment times and why people use payday loans

These loans are typically under $1,000 and can have a repayment period of just a few weeks. Unfortunately, they also tend to come with extremely high-interest rates.

People might resort to payday loans for a variety of reasons. Often, they’re used by people who don’t have access to other kinds of loans or credit.

If someone finds themselves unable to cover an unexpected expense or afford the cost of living between paychecks, they may see a payday loan as their best option.

Good debt or bad debt? Payday loans are one of the most dangerous types of debt, as they have very high-interest rates and short repayment periods. Borrowers often have to pay back the loan in full, plus fees, within just a few weeks.

This can lead to a cycle of debt in which borrowers are unable to pay back the loan in time and must take out another payday loan to cover the cost of the first one as the interest continues to mount.

If you find yourself in desperate need of money, here are 34 ideas that are better than a payday loan.

5. Signature loans

Last on our list of types of debt are signature loans, which are also called unsecured personal loans. You get a lump sum of cash that you can use for whatever you want.

Interest rates and what you need to qualify

Ideally, you'd only pursue this kind of loan for necessary or emergency expenses. Like most types of unsecured debt, the interest rates are generally higher since the lender is taking on more risk (given that there’s no collateral).

That said, if you have a good credit score, a low debt-to-income ratio, and you also have a steady income, you may find it easier to qualify for a signature loan with favorable terms. If you don't have a good credit history or have a high debt-to-income ratio, it will be more difficult.

Good debt or bad debt? Signature loans can be very costly if not paid off quickly. That puts most of them in the “bad kinds of debt” category.

However, if you can get decent terms and you don’t have other alternatives, signature loans can be better than credit cards (and they definitely beat payday loans).

Make a plan to tackle your debt

Given what you’ve learned above about the different sorts of debt, it’s time to take stock of your debts and divide them into your own good or bad categories.

Create a debt list

Start by making a list of your different types of debt, the loan amounts, the interest rates, and the deadlines. Use this list to start prioritizing your debt payoffs.

Consider consolidating what you owe

If you have multiple kinds of debt (especially high-interest debts), you might want to consider debt consolidation.

This is a way to combine multiple debts into one loan, which makes it easier to manage your debt and may help you get a better interest rate.

However, it is important to remember that debt consolidation does not actually reduce the amount of debt you owe; it simply makes it easier to manage.

Once you've made and prioritized your list and decided on a course of action, work hard at it. Even if it takes time, you'll eventually become debt free.

Understand the types of debt and how they work

No matter what type of debt you have, it's essential to understand how it works and how it will affect your long-term financial health.

Some types of debt can be positive if you manage them responsibly, but bad debt can drag you down before you know it. As a general rule, the less debt you have, the better.

If you’re ready to get serious about managing your debt, there are a lot of tools you can leverage. You just need a debt repayment strategy, and then you'll be on your way to a debt-free life!