The word "debt" carries negative connotations, but the reality is more nuanced. Virtually every major corporation, government, and successful individual uses debt strategically. The question is not whether to use debt, but whether the debt is working for you or against you.
What makes debt "good"?
Good debt shares a key characteristic: it finances something that is likely to grow in value or generate income that exceeds the cost of borrowing. The classic examples:
A mortgage funds the purchase of an asset — a home — that historically appreciates over time. If a property rises in value at 3-4% per year and your mortgage rate is 4%, you are roughly breaking even on the pure cost-of-capital basis, but you also get to live in the property (avoiding rent) and benefit from any gains on the full asset value despite only putting down a 10-20% deposit. The leverage amplifies your return on equity.
A student loan for a degree with strong earning power can be good debt. If studying medicine, law, or engineering adds £500,000 in lifetime earnings for a £50,000 loan, the return on investment is compelling. The same loan for a course with weak job prospects and high tuition is a different calculation entirely.
A business loan that funds productive capacity — a piece of equipment, premises, inventory — is good debt if the revenue it generates exceeds the interest cost.
What makes debt "bad"?
Bad debt funds consumption — things that depreciate immediately or generate no income. The clearest examples: credit card balances, payday loans, and car finance for a vehicle you could afford more cheaply.
A credit card balance at 29% APR (the UK average) is devastatingly expensive. If you carry £3,000 of credit card debt for five years at 29%, you pay approximately £2,700 in interest — nearly matching what you originally borrowed. The purchase was almost certainly something consumable that is now worthless.
A payday loan can carry an APR of 1,000% or more — designed for emergencies but frequently used for consumption, creating debt traps that are genuinely destructive to financial wellbeing.
The compounding trap
The most dangerous feature of bad debt is compounding interest working against you. Compound interest builds wealth when it is on your savings and investments. When it is on your debts, it destroys wealth at exactly the same relentless pace. At 29% APR, a £1,000 credit card balance becomes £1,290 after one year if you make no payments — and the interest then accrues on the larger balance.
Good debt is a lever that amplifies your earning power. Bad debt is a tax on tomorrow's income — one you chose to pay today, usually for something that is already gone.
The debt-to-income ratio: the key measure
Lenders use the debt-to-income (DTI) ratio — your total monthly debt payments divided by your gross monthly income — to assess your borrowing capacity. A DTI below 36% is generally considered healthy. Above 43%, most mortgage lenders in the UK become uncomfortable lending more. Managing your DTI is the practical measure of whether your debt is under control.
Practical rules
Always pay off high-interest consumer debt first — the return on eliminating a 29% credit card balance is a guaranteed 29% risk-free gain, which beats virtually any investment. Once consumer debt is clear, build a 3-6 month emergency fund to avoid needing debt in a crisis. Then use debt selectively for assets that appreciate or generate income — not for consumption.