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Debt management: How to evaluate good & bad debt

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For many people, eliminating every bit of debt can feel like a hallmark of financial success. However, prioritizing such a lofty goal could create a stressful and unnecessary burden.

Instead, knowing how to manage debt effectively can make your money work harder for you. It involves understanding the different types of debt, how debt shapes your credit score and how you can strategically control your payments.

What to know about good vs. bad debt

Not all debt is bad debt. Certain types of good debt can build your stability and creditworthiness, helping you reach your financial goals.

The top examples of good debt are mortgages and student loans. When you borrow money to purchase a home you can afford, you're gaining equity. With each mortgage payment, you'll own a bit more of your property. Well-maintained homes typically retain some sellable value, becoming an asset you can leverage. Student loans can be good debt in a similar way—education and skills training usually lead to higher-paying careers.

Bad debt, on the other hand, generally provides no long-term benefits and keeps you underwater. This tends to be money borrowed for items that lose value over time or have excess fees and charges. Prime examples of bad debt are interest-accruing credit card balances and payday loans.

Keep in mind that it's the nature of the debt that matters. A mortgage for a house that's way over your budget would probably be bad debt. Charging necessities to a credit card and paying the balance in full every month can be considered good debt.

Here's a simple high-level check: Ask yourself if a particular debt helps you or burdens you. Recognizing what's serving your broader financial strategy and what isn't can help you make smarter debt repayment decisions.

How debt affects your credit score & credit history

A foundational step in managing debt is knowing how it plays into your financial snapshot, including your credit score. If you put effort into maintaining a good credit score, lenders and creditors likely may offer you more competitive interest rates—making your debt more manageable to pay off over time.

To determine your credit score, credit bureaus typically analyze five aspects of your credit history:

  • Payment history. This accounts for 35% of your score. Pay what you can on time every time.
  • Credit utilization. At 30% of your score, credit utilization measures how much available credit you're using. For example, if you have credit card and other debt totaling $2,500 with a total combined credit limit of $10,000, then your utilization rate is 25%. It's ideal to stay below 10%. If your total rate is above 30%, your score will decrease.
  • Length of credit history. This accounts for 15% of your score. A long, positive credit history means a higher score, so it may be to your advantage to keep accounts open but use them wisely.
  • Credit requests. This is a smaller factor at 10% of your score. If you try to open a lot of new accounts or have a lot of hard credit checks in a short amount of time, it will bring down your score.
  • Credit mix. The last 10% of your score factors in the diversity of your credit use. Showing you can manage a variety of debt could help boost your score.
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4 practical tips for managing your debt

So how do you tackle your debt in a manageable way? Here are some suggestions to get you started:

1. Figure out what you owe

Take a look at all of your debts and add them up. Consider your minimum amounts due and the total balance owed in each account. This can help you spot opportunities for making the biggest strides, such as prioritizing debts with the lowest balances, the largest payments or the highest interest rates.

2. Evaluate your budget

Next, consider your budget. Look at your total income and compare it to your total expenses to spot any room for making extra payments. This will give you a clearer picture of which debts are manageable and how much you can afford to pay down your debt.

3. Look for ways to cut back

While you're examining your monthly numbers, check if there are ways to free up more money to pay down bad debt. Target unnecessary spending that doesn't enhance your life.

4. Sort & prioritize your debts

Once you get a full sense of how much you owe and how much you can afford to pay back, label each type of debt—is it helping you or burdening you? Take stock of which debt racks up high- or low-interest debt, and then consider your payment options:

  • Paying off high-interest debt first. This likely will result in the most interest savings.
  • Focusing on lowest balances first. Seeing accounts go to zero can be very motivating and help you stick to your plan.
  • Tackling high-payment debt first. This requires some balance. For example, it likely doesn't make sense to pay off a mortgage early just because it has the largest payment. But say you have two nearly equal-size debts, but one requires a $300 payment every month while the other has a $100 payment. Getting rid of the higher payment faster may benefit you in the long run.

Keeping your debt under control

Debt management doesn't stop at paying off balances. Find ways to keep that momentum going.

  • Once you pay off accounts, think strategically. It may benefit you to keep certain lines of credit open to improve the credit utilization or credit history length for your credit score.
  • If you need to take on more debt, aim to build good debt and stay away from bad debt where possible.
  • Continually assess and adjust your budget to stay on track.
  • Grow an emergency fund. Instead of spending an unexpected windfall, tuck some money away. Then, if an unexpected need pops up, you'll be able to cover it rather than taking on more debt.

With the right knowledge and a smart strategy, you have the resources you need to effectively manage your debt. You also could consider additional tools to rebuild credit or consolidate debt.

A Thrivent financial advisor can sort through your day-to-day finances with you. They can help you list out your debts, funnel them into the right categories, and strategize around the best repayment plan that fits into your broader financial goals.