Oftentimes, financial experts agree that your total monthly debt payments should not exceed a third of your gross monthly income. Given the value of this metric in establishing a sound financial plan and since it’s next to impossible to live nowadays debt-free, everyone can gain significantly by carefully choosing the mixture of debt that mostly decreases costs and even increases the personal net worth values in the long run. The distinction between good and bad debt is not a technical but a practical one.
Generally speaking, good debt includes anything you need but can't afford to pay for up front without wiping out cash reserves saved for emergencies or liquidating your investments. In all these cases, good debt is investment debt that creates value. In other words, the leveraging power of a loan actually creates more value than the incurred interest costs. Examples of good debt include student loans, real estate loans, home mortgages and business loans. As a consequence, everyone might get a good proportion of good debt to the extent of his/her monthly financial capacity, and benefit from the leveraging effect. Simply put, avoiding debt altogether may not be a smart financial practice in the long term.
On the other hand, bad debt includes debt taken for things you don't need and can't afford. Taking debt to finance something that diminishes in value as time goes by makes it by default bad debt. Examples of bad debt include credit cards, store credit cards, auto loan and the majority of unsecured personal loans. All these forms of debt carry high interest rates and usually have increased transaction and maintenance costs.
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