What is bad debt?
“Bad debt” refers to loans with higher interest rates and fees that prevent you from making progress toward your financial goals. This kind of debt can feel like a burden and leave you feeling overwhelmed. Too much debt can damage your credit score and make it difficult to access credit when you need it.
Here are some examples of bad debt:
Higher-interest credit cards
There is nothing bad about using credit cards. In fact, using a credit card for purchases you can afford and paying at least the required minimum payment or up to the full balance each month may help you build credit and improve your credit score.
But credit card debt can turn into bad debt if you overspend and are unable to pay at least your minimum monthly payment. This type of debt may harm your credit score and make it difficult to get credit in the future.
The Federal Reserve reports that 45% of all U.S. families owe credit card debt, with the average amount owed being $6,270.
What’s more, the interest rate on credit cards can be high (sometimes with an APR of 20% or higher), which makes repayment expensive. (For comparison, personal loan interest rates averaged 10.82% as of April 2023.1)
How can you deal with this type of bad debt? By making a plan for paying it off. One effective way to do this is by consolidating your higher-interest credit card balances into one personal loan with a lower interest rate.
That can make your debt more manageable and help you pay it off faster, bringing you closer to your goal of being debt-free. In fact, 85% of surveyed customers told us taking out a Discover® personal loan for debt consolidation helped improve their financial future.*
Payday loans
Also called cash advances, payday loans are among the most expensive kinds of debt you can have. These are short-term, high-interest loans for small amounts that you must pay back quickly—usually by your next payday. Unless you have no other choice, try to avoid payday loans because they could make your money problems worse.
Payday loans can have APRs as high as 400%, according to the Consumer Finance Protection Bureau. This is expensive money to borrow and can lead to even greater financial struggles. Just how expensive are payday loans? Consider this: Over the course of the year, a borrower may spend more than $1,500 in interest to pay back a $500 payday loan with a 300% APR.
Also, even if you pay back the loan on time, it won’t help your credit score. That’s because payday loans generally aren’t reported to the credit bureaus.2 On the other hand, if you become delinquent on your loan, a collection agency might report it.
Turning bad debt into good
The good news is that you can change bad debt into debt that helps you make progress toward your financial goals. The first step is getting a clear picture of what you owe to each lender. Then you can decide the best way to wipe out those debts.
Balance transfer card
One option is a balance transfer credit card. These cards let you transfer the balance of one card to another with a zero-interest introductory period. Just remember: Once the interest-free period ends, you will be charged the standard interest rate on whatever balance is left.
Balance transfers could be good short-term solutions for smaller debts—if you can pay off the balance within the zero-interest period.
Debt consolidation loan
A better long-term solution may be a personal loan for debt consolidation. There are several benefits to a personal loan:
- You lock in a fixed interest rate, so your monthly payments don’t change.
- You simplify your finances with one set regular monthly payment to one lender, instead of managing several different loans or credit card balances with different payment amounts and due dates.
- And maybe the best benefit? Because a personal loan is an installment loan, you will know exactly when you’ll be debt-free. In fact, 88% of surveyed debt consolidation customers told us they paid off existing debt sooner with a Discover personal loan.
Credit counseling
If you’re struggling to keep up with higher-interest debt and need help sorting through your options, you may think about working with a credit counselor. A credit counselor is a trained professional who can give you expert guidance on how to budget, negotiate with creditors, and create a debt management plan. The first session is usually free. There are organizations like the Consumer Protection Financial Bureau that can help you find an accredited credit counseling agency.
The bottom line
Defining debt as good or bad is all about what it can do for you. Is your debt working for you or holding you back? Once you know how debt can help you succeed, you can make it a healthy, productive part of your life and use it to build a better financial future.
Take the first step toward improving your credit health. Use our debt consolidation calculator to see how much you could save by consolidating higher-interest debt with a Discover personal loan.