"Never borrow money" sounds wise, but it would mean almost nobody goes to college, buys a home, or starts a business. "Borrow whenever you want something" ends in 24% APR misery. The truth is in between: debt is a tool, and like any tool, the question is what you're using it for and what it costs. This lesson gives you two frameworks — good vs bad debt, and the debt-to-income ratio — plus a battle plan if you're already carrying balances.
The two questions that sort all debt
Before borrowing, ask:
- Does this purchase tend to grow in value or earning power — or shrink?
- Is the interest rate low enough that the math can work in my favor?
"Good" debt generally finances something that builds wealth or income, at a low rate:
- Mortgages (typically ~6–7% lately): homes historically hold or grow value, and you'd pay rent anyway.
- Federal student loans (~5–8%): a degree raises lifetime earnings on average — though the amount and the major matter enormously.
- Business loans that fund something generating income.
"Bad" debt finances consumption — things that lose value the moment you buy them — usually at high rates:
- Credit-card balances (~20–25% APR) carried month to month.
- Payday loans (often 300–400% APR — see the next lesson).
- Financing for furniture, electronics, vacations — "buy now, pay later" plans included, when they pile up.
A useful tie-breaker: compare the loan's APR to the ~7% long-run average return of investing (covered in the retirement track). Borrowing at 5% while your money compounds at 7% can be rational. Borrowing at 24% never beats anything.
DTI: the number lenders judge you by
When you apply for a mortgage, car loan, or apartment, lenders compute your debt-to-income ratio (DTI):
DTI = total monthly debt payments ÷ gross monthly income
"Debt payments" means minimum required payments: rent or mortgage, car loan, student loans, card minimums. (Utilities, groceries, and subscriptions don't count.) "Gross" means before taxes.
Already carrying bad debt? Two proven payoff strategies
List every debt with its balance, rate, and minimum. Pay minimums on everything (always — late payments wreck credit), then aim every spare dollar at one target:
- Avalanche — attack the highest interest rate first. Mathematically optimal: kills the most interest.
- Snowball — attack the smallest balance first. Psychologically powerful: quick wins keep you going, and each cleared debt frees up its minimum payment for the next.
Avalanche saves more money; snowball keeps more people in the game. Research on real borrowers suggests the strategy you'll stick with is the right one — and if your highest-rate debt happens to be small, the two strategies agree anyway. For card debt specifically, the credit card payoff calculator shows exactly how many months any payment plan takes — and what minimum-only payments really cost.