Remember that scene in The Wizard of Oz when Dorothy is shocked to learn that Glinda is a witch because she thought all witches were ugly? Well, if you’re recovering from bankruptcy or just working to become debt-free, you may have a similar notion, but about debt.

The truth is, debt is like witches: some of it is, indeed, harmful, but other types are healthy.

Debt & Our Credit Profiles

To understand the difference between good and bad debt, it’s important to understand the role debt plays in our lives as consumers:

• Your credit report: As you may know, your credit report is a compilation of information about your spending, borrowing and payment habits from a variety of sources—banks, credit card companies, utility companies, mortgage holders, etc. It provides a snapshot of how you handle money and credit.
• Your credit score: This is a number derived from a specific formula, based largely on the information in your credit report. Factors that influence your score include age of accounts, diversity of accounts, currency of account payments and percentage of available credit being used.

When you attempt to borrow money, most lenders will determine whether to lend to you—and at what rate—based on your credit score.

Good Debt

Naturally, if you use no form of credit, your credit report will be blank. Lenders will have no way to assess your risk as a borrower and will be unlikely to offer you a loan (even if you’ve paid your bills on time for years).

Good debt, then, includes:

• Debt with a goal: Student loans can be considered “good” because they might lead you to a better-paying job. An affordable mortgage leads you to a time when you don’t have to pay to live somewhere.
• Diverse sources: Even having a credit card you rarely use can be considered “good” debt, because it provides diversity to your borrowing portfolio and expands your total credit available.

Bad Debt

The kind of debt that would terrorize munchkins and young girls is the kind that doesn’t really get you anywhere and doesn’t provide anything you need. Credit card debt is often “bad,” because credit cards are easy to use for non-essential purchases.

As a general rule of thumb, before taking on new debt, determine whether you’re getting something you truly need in exchange. If not, it’s likely going to be “wicked” debt.

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