Before you take out a loan, you should understand the difference between good debt and bad debt. Although many people think this is about the kind of credit product chosen, it is more accurate to think of it as being about the way the money gets used and the reasons for seeking the loan.

Consumer Debt

Investopedia says consumer debts are Debts that are owed as a result of purchasing goods that are consumable and/or do not appreciate. This is stuff like spending money on clothes you do not really need or paying for fancy restaurant meals with a credit card instead of cooking it yourself at home for a fraction of the cost.

Generally speaking, consumer debt is bad debt. It amounts to blowing money you do not have to consume things you do not really need. It can be an incredibly bad habit that is hard to break. This is a good way to get into trouble. It can lead to chronically living beyond your means.

If you habitually borrow to cover basic expenses, you are in trouble. You need to start tracking your expenses, and you need to start working to cut costs, increase income or both.

Debt That Pays for Itself

Good debt is debt that pays for itself in some ways. Borrowing money to pay for the proverbial "stitch in time" can be in this category. For example, putting a small repair or small car maintenance bill on a credit card instead of putting it off until the problem is bigger and more expensive.

The amount of interest paid on this small preventive measure pales in comparison to the amount it would have cost you had you waited. This is why we have expressions like "penny wise and pound foolish." Sometimes, being stingy about small expenses costs us far more in the long run.

Old Ideas, New Reality

Mortgages, student loans and business loans are routinely classified as good debts because they are routinely assumed to be debt that will pay for itself. But this is not always the case. The housing market is pretty crazy these days and student loans are out of control. You cannot count on those products to automatically be a good idea. You need to understand what you are getting into.

There is no simple formula for deciding which loans are good and which are bad. Context matters and there can be many factors in life to consider before concluding that a particular loan is a good idea for you at this time in your life.

You need to not only know the larger landscape of your life, you need to know yourself. Will you actually use the debt in a responsible fashion? If you will not, there is no "right" credit product. If you are your own worst enemy, no one can protect you from yourself.

Debts can be a tool to help us get the most of out of life. But only if we use them properly.