Most financial advisors advocate that consumers have no more than 36 percent of their total gross income allocated to debt repayment — including house payments, car payments, insurance payments, medical payments, credit cards, and student loans. It is important to make smart money decisions by differentiating between good and bad debts — maximizing one and minimizing the other.

Basically, when a debt vastly increases the actual amount to be paid for a product that doesn't increase in value, it's a bad debt. When debt is used purposefully and intelligently to build wealth, such as to invest in a solid business venture, it's a good debt. Some examples include the following:

• When you buy a product on a credit card or by acquiring a loan, and that product immediately goes down in value, or loses any potential to gain in value, that's a bad debt.

• When you borrow to buy something that will result in increased value — by taking out student loans, real-estate loans, home mortgages, and business loans, for example — that's a good debt.

• When you have debts that are tax-deductible or that will produce more wealth in the long run, they are also good debts, provided you repay them as soon as possible.

Taking a second mortgage to pay down credit card debt can turn bad debt into good debt, particularly if you obtain a home-equity loan with a tax-deductible, 6 percent interest rate to pay down credit card balances logging 20 to 30 percent interest — provided you pay it off as soon as possible and don't max out your credit cards again.

In general, buying a home or refinancing to vastly reduce excessively high interest rates is usually good debt, as is generating limited debt to buy investments that are virtually guaranteed to meet expectations within a short period of time. (Note that stocks can be unexpectedly volatile and rarely justify a home equity loan.)

Credit cards generally create bad debt. If you paid off your balances in full every month, prior to the grace period, you wouldn't pay any interest and would thus avoid generating bad debt. Unfortunately, few of us are able to pay the balances in full each month. In fact, the vast majority of people overcharge and end up paying the minimum amount due, which immediately generates bad debt. And once you're under the elephant that maxed-out, high-interest credit card debt quickly becomes, it's exceedingly hard to dig your way out — and it's very, very costly.