Does the word “debt” give you a warm, fuzzy feeling or an attack of the heebie-jeebies? For most people, the reaction is typically somewhere in between. Too much debt can of course limit your choices and cause stress. On the flip-side, achieving many of our biggest life milestones involves taking on some debt. Buying a home, getting an education, starting a business, making home improvements… For most people these would all be out of reach if it wasn’t for the ability to borrow money.

Like any money tool, knowing how and when to use debt is the key to delivering the results you want. That’s where understanding the difference between “good debt” and “bad debt” comes in.

Let’s look at the types of debt and how you can make smart, i.e. thoughtful and responsible, borrowing an important part of your money journey.

Understanding debt: The good, the bad, and the useful

Debt is simply money you borrow and agree to repay—usually with an amount payable in interest. People borrow for all sorts of reasons. The most common are to:

• Buy something you can’t pay for outright, such as a home
• Spread the costs of something over the longer-term, such as a car or family vacation
• Take advantage of an opportunity, such as an investment or home improvements
• Build skills and gain an education
• Start and grow a business
• Cover urgent or unforeseen expenses, such as unexpected travel or funeral costs
• Cover the cost of living expenses, such as groceries and bills

Knowing how much to borrow

Before you borrow a cent, it’s important to consider what you can afford. Your Coastal Community financial advisor can help you understand something called your “debt-service ratio.” This is a term for the percentage of your monthly income eaten up by repaying, or servicing, your debt. Imagine your income is a cake. How big a slice of it goes toward your mortgage, car loan, credit card, student loan payments, and other debts? That’s your debt-service ratio, or how affordable and manageable your debt is.

For example, if you earn $4,000 a month and pay $1,200 a month toward your debts, your debt-service ratio is 30%. For those who like seeing the math, that’s (1,200/4,000) x 100.

The higher that percentage, the less money you have left over for everything else. That means you may not be able to afford that much debt. There’s no “ideal” size for that slice of cake going toward debt, but if it’s 40% or more that can make life more stressful. It might be hard to save money, and you may feel more like you’re living paycheque to paycheque. Coping with life’s unexpected events could also be harder, and you may end up borrowing even more money just to pay off debt.

Your debt-service ratio can change as you move through life. In your 20s and 30s, you want to try to keep it to no more than 30%. In mid-life, up to 35% is usually manageable. Near or at retirement, you want your debt to reduce as you age to between 20% and 30%.

At this point, you might be thinking, “Shouldn’t my aim be no debt at all?” Well, yes and no. You first need to consider the types of debt and the idea of “good debt.”

Types of debt

Debt comes in all shapes and sizes. Each has its own purpose and comes with its own costs, risks, and benefits. Here are the six most common types of debt:

1. Mortgage: Borrowing to buy a home and pay it off over a pre-agreed period, such as 25 years. This is most people’s biggest single life expense.
2. Student loan: Borrowing to fund training or an education, with a view to paying it back over time when employed.
3. Line of credit: A pre-agreed amount of money, such as $5,000, that you can access any time you need it and repay it over time.
4. Credit card: A convenient and quick way to pay for things on a day-to-day basis, with a view to paying off the balance regularly.
5. Business loan: An agreement to borrow a set amount of money, repayable within a set period, to help start, grow, or manage a business. This could include start-up costs, commercial property, or new equipment.
6. Personal loan: An agreement to borrow a set amount, repayable with a set period, for a variety of uses, such as home improvements.

Good debt vs. bad debt

Understanding which debts help you grow and which ones drain your resources is the first step in turning borrowing into a useful money tool.

Good debt is considered smart borrowing. It typically comes with manageable repayment terms and reasonable interest that keeps you within your ideal debt-service ratio. This type of debt is also good because it can increase your wealth or earning potential in both the short- and long-term, e.g.:

• Becoming a homeowner
• Further education
• Value-adding home renovations, such an income suite
• RRSP “catch-up loans” to help save for retirement and reduce tax

Bad debt is the riskier approach. It’s characterized by higher interest rates (e.g., credit card balances, payday loans), and often involves borrowing for things that don’t have long-term value and without much consideration of the impact on overall finances or a clear repayment plan. Examples of bad debt include:

• High-interest credit cards
• Payday loans
• Unplanned or impulse purchases
• Borrowing to maintain a lifestyle beyond your means
• Debt that piles up without you noticing, such as TV streaming subscriptions or apps you don’t use much that auto-renew each year

The real danger of too much bad debt is it can lead you into a cycle of borrowing that’s hard to get out of. It can negatively affect your credit score, making it harder to take on good debt.

Smart borrowing for SMART goals

Figuring out what and when to borrow can be stressful in itself. If you’ve ever done any goal-setting, the SMART (Specific, Measurable, Achievable, Relevant, and Time-bound) method might ring a bell. SMART works just as well when deciding when to borrow money.

Before taking on new debt, ask yourself:

• Specific: What exactly am I borrowing for?
• Measurable: How do I know it’s worth it?
• Achievable: Can I comfortably make the payments?
• Relevant: Do I really need the thing I’m borrowing money for?
• Time-bound: When will I finish paying it off?

Here are some examples of goal-oriented borrowing that could help you focus on good debt, depending on your individual situation:

• Home improvements, such as weatherproofing or a new kitchen, that add value and save on bills
• Business growth, such as equipment, marketing, or expansion that increases income
• Education, such as skills and qualifications that boost your earning potential
• Retirement savings, such as RRSP loans that help you max out your contributions and save on tax
• Income stream development, such as a rental suite, small business start-up costs, or equipment for a side-gig

Keep an eye out for ways to turn borrowing into an investment in YOU, such as government rebates for eco-friendly home upgrades, business grants, or education tax credits.

6 smart ways to keep debt working for you

As well as having smart borrowing goals, smart borrowing is all about understanding the types of debt you have, using tools to manage it, and generally being more thoughtful about your borrowing. For example, rewarding yourself with a brand new car after a job promotion is a great idea now. However, consider what “future you” might say in five years time when maybe you want to buy a home or do something else, but you have a large monthly car payment. The point is that debt can both limit and create opportunities.

Even good debt needs to be managed well. Here are some smart strategies to help you manage and repay debt, and make best use of the tools available to you.

1. Pay off high-interest debt first

Credit cards and payday loans can cost far more in interest than other debt types, so it makes sense to always pay them off as quickly as you can.

2. Have a plan for low-interest debt

Mortgages, student loans, or lower-interest lines of credit can be paid down over time, but you still need to have a repayment plan and stick to it.

3. Transform bad debt into good debt

As you move through different life stages, you may find yourself with lots of credit cards, various loans, and other debts. Sometimes you may be able to consolidate multiple debts, especially credit cards and higher-interest loans into one lower-interest place, such as a line of credit.

4. Redirect savings

Channel money saved from lifestyle changes (like a staycation instead of a trip or fewer takeout meals) directly into debt repayment.

5. Use tools wisely

Use the Cardwise app to track your Coastal Community Collabria credit card spending and earn rewards, including cash back that you can redirect into debt repayments. Collabria credit card balance transfers can also lower your interest rate. Even if you don't have a cashback credit card, you can still cash in your reward points to pay down your credit card balance. You can also do this in the Cardwise app.

6. Go for a debt check-up

A debt check-up as part of an all-over money review with a Coastal Community advisor can:

• Give you a clear view of your current borrowing
• Show you ways to save on interest
• Match your borrowing with your overall money goals

Ultimately, making friends with good debt and avoiding too much bad debt can keep you moving toward your goals, and make you feel better about your money situation.