Good debt, bad debt

Two people borrow £10,000 in the same week, at the same rate. The first uses it to retrain as an electrician; within two years she’s earning £8,000 more a year than before. The second puts it on a fortnight in the sun, eats well, comes home, and the money is gone. Same loan. Same cost. But one person is now richer than before they borrowed, and the other is poorer. We’re taught to sort debt into “good” and “bad” as if the loan itself carried the morality. It doesn’t. The loan is just arithmetic. What makes it good or bad is what you point it at.

Debt isn’t moral, it’s a rate comparison

The whole confusion comes from treating “good debt” and “bad debt” as character labels — sensible people take good debt, reckless people take bad debt. Drop that. There is only one question that decides which kind you have.

Does the thing you buy with the money grow or earn faster than the loan costs?

That’s it. Every loan has a cost — a rate, its APR, the true yearly price you met in the last item. And the thing you buy with the borrowed money does one of three things: it earns you money, it grows in value, or it does neither. Line the two rates up against each other. If what the money buys returns more than the loan charges, the debt built something worth more than it cost. If it returns less, you handed over more than you got back. You’re poorer.

So “good” and “bad” aren’t about the loan. They’re about a race between two numbers: the return rate of the thing, and the cost rate of the borrowing.

The good case: the return beats the cost

Take the electrician. She borrows £10,000 at 5% a year. That loan costs her roughly £500 in interest in the first year — the price of pulling that money forward in time.

What does the £10,000 buy? A skill that lifts her earnings by £8,000 a year, every year, for the rest of her working life. Put that as a rate of return on the £10,000 she borrowed: £8,000 on £10,000 is 80% a year. Now stand the two numbers next to each other. The money costs 5%. The thing it buys returns 80%. The return crushes the cost. After she’s repaid the loan, she keeps the higher wage for decades. The debt was an engine: it cost £500 to start, and it built something worth far more.

A mortgage often works the same way. Borrow to buy a home, and yes, you pay interest for years. But you’d have paid rent anyway — rent that tends to rise — and the home itself usually holds or grows its value. The borrowed money buys you out of a rising cost and into an asset. The loan’s rate is the cost; the rent you escape plus the home’s growth is the return. When the return wins, the debt is doing real work.

The bad case: the cost beats the return

Now the holiday, on a credit card at 30% a year. The £1,000 trip is wonderful. Then it’s over. The memories are real, but they don’t earn a penny and they don’t grow in value — the return is 0%. The cost is 30%.

Stand the numbers up: the money costs 30%, the thing it buys returns nothing. You are poorer the moment the plane lands, and it gets worse from there — because at 30%, as the debt-spiral item showed, the interest compounds against you. The same engine that built the electrician’s wealth now runs in reverse, digging a hole. A gadget that loses half its value the day you open the box is the same story: high cost, negative return.

Notice this is the identical loan structure as something sensible — money borrowed, repaid with interest. The arithmetic of the borrowing is fine. What’s broken is the match: an expensive loan funding a thing that returns less than it costs.

The grey case, and the honest catch

Most real decisions live in the murky middle. A car loan is the classic. A car is a tool — it gets you to a job you couldn’t otherwise reach, so it earns. But it also loses value every year, so it costs, beyond the loan. Borrow at 6% for a car you genuinely need to work, and the job it unlocks may easily out-earn the cost — good debt. Borrow at 12% for a flashier car than the job requires, and the depreciation plus the interest can swallow any benefit — bad debt. Same object, opposite verdicts, decided by the rate and the need.

And here’s the catch the cheerful version hides: “good debt” still has to be repaid, on time, whatever happens. The return is a forecast, not a promise. The electrician’s 80% assumes she finishes the course and finds the work. So the real test isn’t just return beats cost — it’s return beats cost with enough margin to survive if things go wrong. A return of 6% against a cost of 5% is technically “good,” but one bad month wipes the gap. Borrow where the return clears the cost comfortably, not by a whisker.

On the whole

Strip away the labels and a borrowing decision is one clean question. Not “is this good debt or bad debt?” — that asks the loan to carry a morality it doesn’t have. The question is: does this borrowing buy something that out-earns what it costs, with room to spare? A 5% loan can be reckless and a 30% loan can — very rarely — be worth it; it depends entirely on the other number in the race.

This is the same machine you’ve been watching all along. Interest is the price of time. Compounding runs in both directions. APR is the true cost. Here those threads tie together: borrowing is just compounding pointed at a future, and whether it builds you up or grinds you down depends on whether the thing you bought is growing faster than the debt. You are always standing between two rates. The skill is learning to see both before you sign — and to remember that the future paying off the loan is a real person. It’s you, a little further down the road, living inside the bet you made today.