How to differentiate between Good Debt and Bad Debt

 Bashi (in Hausa), ụgwọ (in Igbo), gbèsè (in Yoruba) are the translations of the word ‘debt’ in the 3 major languages of Nigeria. Whether it is said in Hausa, Igbo or Yoruba, it is known as a bad thing, a bad place to be.

Debt is often painted as the bad guy in conversations about personal finance, something to avoid at all costs. We need to learn that not all debt is harmful, and debt can be used as a tool. The real problem is not borrowing itself, but borrowing without clarity or intention. When you understand the difference between good debt and bad debt, you stop making emotional financial decisions and start making strategic ones. You start to see how some debts can help you grow your income, build assets and even create opportunities, while others quietly drain your future earnings and limit your freedom.

Knowing the difference is important because it influences how you earn, spend, invest, and plan your life financially.

What is bad debt?

You can define it as money used to ‘chop life’ (for lavish spending).

Bad debt is any money you borrow to buy things that are consumed quickly, lose value with time, or things that don’t generate any income to help you pay back the loan. It is the type of borrowing that decreases your net worth and makes you financially weaker.

An example is borrowing money to throw a massive owanbe (party) instead of a modest celebration just to impress or satisfy people. After the party, as they leave with their bellies filled, you are left with the loan to pay.

How to identify bad debt

Let’s look at ways to spot bad debt so you can ‘jump and pass’ (avoid it).

1. It comes with high interest rates

Bad debt usually comes with very high interest rates. Before you know it, the money you have to repay is far more than the original amount you borrowed (especially when you exceed the payment deadline).

 2. It is consumption-focused

The debt is bad when you use it to finance immediate gratification, wants, or things that are consumed.

Aunty Nkechi borrowing to buy expensive designer clothes for her friend’s party next week. These are purely expenses that do not add money back to the pocket.

Remember to live below your means, cut your coat according to your cloth.

Read: 11 Money Habits Every Nigerian Should Develop Before 30

 3. Its value depreciates

Buying an item that loses value with time is incurring bad debt on yourself. Mr. Femi buying a tear-rubber luxury car to show off. The minute he drives that car out of the showroom in Lagos, the value drops significantly. In five years, it might be worth as low as half of what you borrowed, but you still have to pay back the full original loan, plus interest. (put an example of a car that was expensive now and is cheaper now)

 To identify bad debt, just ask yourself this one question: Is this borrowing going to make me more money, or going to help me show off for a while? If the answer is the latter, then it is a bad debt. You should run.

 

What is good debt?

We have talked about bad debt. Now, let’s talk about good debt.

Good debt, as mentioned earlier in the introduction, is debt used as a tool. It is money you borrow that is likely to increase your net worth or generate future income for you. It is a strategic investment, not just something you use to ‘flex’(show off) or consume immediately.

It is like taking a loan to buy a Keke Napep to use for a transport business. In the long run, it is a money-generating source.

 How to identify good debt

To know if a debt is good, check these characteristics.

1. It is used for value creation:

It is used to build something. Good debt is used to acquire assets that hold or grow value over time. Think of acquiring a piece of land in a rapidly developing area like Lekki or Abuja. Even if you borrowed the money, the land’s value will likely multiply in a few years, making you a profit when you sell. 

2. It is used as a seed fund for a business:

It is classified as good debt if you use the borrowed money as a seed to help you plant a business that will yield profit, increasing your ability to earn money.

Using a business loan to stock up your provision store with in-demand products before the December rush can be classified as a good debt. Another example is buying a generator for power supply in your workspace. 

3. It is used to invest in something with long-term benefit:

The positive returns from this debt outweigh the interest you have to pay back, and the benefit lasts for years. For example, a loan taken to pay for a degree in a high-demand field or a high quality vocational skill course. Yes, you pay back the loan, but the degree potentially unlocks a higher-paying salary for the next 20-30 years of your career. Some government-backed student loans are interest-free (like the NELFUND loan) reducing the burden on the students.

It increases your earning power permanently. You become more marketable and can command a higher salary in the job market, making the loan easy to service.

 

Should we incur good debt intentionally?

The short answer is YES. This is the concept of leverage, using the bank’s money to multiply your own returns. Some very large successful business owners did not achieve that size using only their savings. They used a capital injection which some had to pay back. Good debt helps you acquire at the moment, money that would take you years to save for, locking in today’s price and benefiting from tomorrow’s appreciation.  

Why wait 5 years to save ₦1 million to start a production business when you can take a loan today, start earning ₦3 million profit annually, and pay off the debt in 3 years?

 

When should we incur good debt?

Knowing what to borrow for is good, but knowing when to borrow is important too.

1. When the return (ROI) is clear and high: 

Only borrow when you have calculated and made sure that the expected profit is significantly higher than the total cost of the debt (principal + interest). For example, if a loan for new machinery costs you ₦1 million in interest, but the machinery is projected to increase your annual profit by ₦3 million, then you can go ahead. The return on investment must make the debt look cheap.

2. When inflation is eating your savings: 

In a country like Nigeria where inflation can be high, delay is deadly. If you are saving money to buy an appreciating asset (like a house or land), and the price of the asset is rising faster than the interest on your savings account, then you should borrow to buy it now. If land is appreciating by 20% annually and your savings account is giving you 5% interest, you are losing about 15% yearly. Borrowing now locks in the price and stops the loss.

Read: 5 Best Tips to Navigate Through Inflation in Nigeria

3. During economic expansion or sector growth: 

If you are seeing a boom in a specific sector, that is the time to borrow money to expand your capacity and take your share of the cake. For example, if there is a sudden surge in demand for locally produced goods, you can get a loan to buy more raw materials and expand your factory line immediately. It is important to strike while the iron is hot.

 

How to incur good debt?

The fact that good debt is good and is advised doesn’t mean you should just act at random. It must be done with structure and professionalism.  These are things to know when getting a good debt.

1. Define the purpose and document your plan:

If it is a business loan, have a solid business plan and cash flow projection. Know exactly how the borrowed money will generate profit. Don’t just go to the bank and say, I need money for business. Say, I need ₦5 million to purchase a high-yield rice mill, which will process 10 tons per week and generate ₦7 million in revenue annually, allowing me to pay off the loan in 18 months. This level of detail presents you as professional and prepared.

2. Look for the lowest interest rate with best terms and conditions: 

Take your time to compare lenders (banks, microfinance banks, cooperatives and development banks) to find out the ones with the best rates. After getting the offer, try to negotiate to see if you can get an even better offer.

3. Build a safety net: 

When taking on good debt, never borrow to the absolute maximum of your expected earnings. You must have an emergency plan and fund. This is to protect you in case of unexpected happenings. What if the Keke Napep breaks down for two months? What if the contract payment is delayed? Your safety net will save you from defaulting on the loan and ruining your credit score.

In conclusion, two points you should have gotten from this post are:

-        Debt itself is neutral, it is the use that makes it good or bad.

-        Borrow to build, not to burn.

The ultimate goal is to borrow smartly, grow your wealth quickly, and be the person lending the money to people one day.

This article was written by Damilola Abraham Olágúnjú, a personal finance enthusiast who helps individuals build healthier money mindsets and make smarter everyday financial decisions. You can read his full profile and check out his articles here.