Bad debt meaning
Simply put, a bad debt is a type of expense that occurs after repayment by a customer (when credit has been extended) is no longer considered to be collectable. In other words, bad debt is an irrecoverable receivable.
Bad debt is debt which you owe that does not directly help you achieve cash flow. For example, bad debt would be credit card purchases for goods and services which you will consume. (This is assuming that you are carrying debt on the credit card and not paying off the balance before any interest is charged.)
Good debt is using a loan to buy something that is expected to make you money over the long-term. This includes buying a house (mortgage) or starting a business (business loan) or education (student loan).
In fact car loans can be considered bad debt since cars are depreciating assets.
Mortgages are seen as “good debt” by creditors. Since the mortgage debt is secured by the value of your house, lenders see your ability to maintain mortgage payments as a sign of responsible credit use.
Debt for discretionary spending: Taking out a loan to pay for a vacation, designer clothing, hobbies or other discretionary spending could be considered bad debt.
Key takeaways
Debt-to-income ratio is your monthly debt obligations compared to your gross monthly income (before taxes), expressed as a percentage. A good debt-to-income ratio is less than or equal to 36%. Any debt-to-income ratio above 43% is considered to be too much debt.
Ninety-three percent of millionaires said they got their wealth because they worked hard, not because they had big salaries. Only 31% averaged $100,000 a year over the course of their career, and one-third never made six figures in any single working year of their career.
High-interest loans -- which could include payday loans or unsecured personal loans -- can be considered bad debt, as the high interest payments can be difficult for the borrower to pay back, often putting them in a worse financial situation.
They stay away from debt.
Car payments, student loans, same-as-cash financing plans—these just aren't part of their vocabulary. That's why they win with money. They don't owe anything to the bank, so every dollar they earn stays with them to spend, save and give! Debt is the biggest obstacle to building wealth.
The Worst Type Of Debt: Payday loans
Payday loan interest rates can run over 100% a year. Payday loans give people who run out of cash a loan to pay their bills. Payday loans are a short-term loan that should last only a month or two. However, roughly 80% of payday loan borrowers are repeat customers.
Technically, "bad debt" is classified as an expense. It is reported along with other selling, general, and administrative costs. In either case, bad debt represents a reduction in net income, so in many ways, bad debt has characteristics of both an expense and a loss account.
Wealthy family borrows against its assets' growing value and uses the newly available cash to live off or invest in other assets, like rental properties. The family does NOT owe taxes on its asset-leveraged loans because the government doesn't tax borrowed money.
Back-end DTI focuses on all of your monthly debt, not just housing. This could include your mortgage as well as auto loans, student loans, personal loans and credit cards. It does not include daily expenses such as groceries, utilities or medical bills (in many cases).
70% of Millionaires Go Broke: How to Avoid the Pitfalls of the Wealthy.
13% of American workers aged 15 and above made more than 100k in 2021. The annual income of over 34% of American households exceeds $100,000.
Here's a little secret: Compound growth, also called compound interest, is a millionaire's best friend. It's the money your money makes. Seriously.
Generally speaking, cars purchased with a large down payment and with a short-term car loan are considered to be good debt. That's because large down payments usually mean lower interest rates. Further, a shorter loan term means you'll pay less in interest over the life of the loan.
If you're carrying a significant balance, like $20,000 in credit card debt, a rate like that could have even more of a detrimental impact on your finances. The longer the balance goes unpaid, the more the interest charges compound, turning what could have been a manageable debt into a hefty financial burden.
According to Experian, average total consumer household debt in 2023 is $104,215. That's up 11% from 2020, when average total consumer debt was $92,727.
Even though your card issuer "writes off" the account, you're still responsible for paying the debt. Whether you repay the amount or not, the missed payments and the charge-off will appear on your credit reports for seven years and likely cause severe credit score damage.
The Bottom Line. Bad debt is debt that cannot be collected. It is a part of operating a business if that company allows customers to use credit for purchases. Bad debt is accounted for by crediting a contra-asset account and debiting a bad expense account, which reduces the accounts receivable.
What is Toxic Debt? The most obvious answer is high interest revolving credit. This could be in the form of a payday loan, credit card, personal loan, etc.