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The word debt carries a negative connotation, but people sometimes differentiate "good debt" from "bad debt." Debt that helps you acquire appreciating assets, like a house or a business, is generally considered good. Debt backed by collateral that you could sell if necessary, like a car, could be good or bad depending on the terms of the loan.
But there is one type of debt that seems to always be labeled bad — credit card debt. Here’s why that is.
While credit card debt can be "bad," credit cards themselves are not inherently bad. They're merely financial tools. Moreover, saying that credit card debt is "bad" is not a value judgment on the person carrying such debt. No one is "bad" for leaning on credit cards for, say, medical care or to put food on the table when they have no other options. "Bad debt" is debt that doesn't provide something of ongoing value to the person who owes it, whether that's a place to live, a car to drive or an education. "Bad" just means it's debt that's best avoided if possible and, if you have it, should be the first debt you work on paying off.
1. It comes with double-digit interest rates
Credit card debt is typically the most expensive debt you can take on. Interest rates on credit cards are typically well into the double-digits and often above 20% — even for people with good credit. By contrast, the best interest rates on student loans, mortgages and personal loans can be well under 10%. This is why it's generally not recommended to put large expenses like medical debt on credit cards if you can avoid it. There may be much cheaper options available.
2. The minimum payments will take you years to pay off the balance in full
If you want a good laugh — or scare — check out the "minimum payment warning" on your credit card statement. It tells you how many years and months it will take for you to pay off your credit card debt making only the minimum payment. Let’s say you have a balance of $8,000 on a credit card with 18% interest and a minimum payment of $160. If you make only the minimum monthly payment, you won’t pay off the credit card for seven years and seven months and you’ll pay $6,432 in interest.
If you choose to double your minimum payment and pay $320 a month, your debt will be wiped out in two years and seven months, and you’ll only accrue $1,912 in interest. Simply by doubling your payment, you’ll save five years and $4,520 in interest payments. If you have credit card debt, always pay much more than the minimum to save time and money.
3. It doesn't represent an investment
“Good” debt is typically defined as mortgage, education or business debt because, ideally, each of these investments will generate returns for years to come.
Mortgage or real estate debt is generally most profitable for those who own rental properties, but there’s also a possibility of making money from your personal residence when you sell it. Education debt is supposed to help you get a job with a better salary than you would get with a high school diploma. And business debt can be a great investment if the business succeeds. Of course, every investment requires taking some risk, but calculated risk can result in large rewards.
Credit card debt isn’t used to buy appreciating assets. It may be used for depreciating purchases — like home furnishings, clothing items or gadgets — or consumables, such as food and gasoline. There's nothing wrong with any of these purchases, but paying interest on them is unnecessary and can raise their true prices significantly.
A good rule of thumb is to avoid going into debt purchasing things that won’t go up in value. Should you cut up all your credit cards? No, just don’t spend more on them than you can afford to pay in full each month before any interest accrues. Credit cards are a great tool when used correctly, but credit card debt is cripplingly expensive — so don’t carry it over from one month to the next if you can avoid it.
The bottom line: Credit card debt is considered "bad" debt because of its high interest rates and low minimum payments, and the fact that it isn’t used to buy appreciating assets. Use your credit cards for the rewards and other benefits, but pay the balance in full each month.