Good Debt vs Bad Debt

"Debt is slavery," say some. "Debt is leverage," say others. Who is right? Both. It depends on what you buy with that debt.

The Simple Definition

• Good Debt: Puts money IN your pocket (or increases your value).
• Bad Debt: Takes money OUT of your pocket.

1. Good Debt (Investment)

Debt taken to buy an asset that appreciates in value or generates income.

Examples:

1. Education Loan:

   • Why: Increases your earning potential (Salary).
   • ROI: High. A ₹10 Lakh loan might get you a job paying ₹15 Lakhs/year.
   • Tax Benefit: Interest is tax-deductible (Section 80E).

2. Home Loan:

   • Why: You stop paying rent and build an asset. Property value usually goes up.
   • Tax Benefit: Interest (Section 24) and Principal (Section 80C) deductions.
   • Caveat: Only good if EMI is affordable (Less than 30% of income).

3. Business Loan:

   • Why: To expand business, buy machinery, increase profit.
   • ROI: If business grows 20% and loan interest is 12%, you make 8% profit using bank's money.

2. Bad Debt (Consumption)

Debt taken to buy things that lose value (depreciate) or just for consumption.

Examples:

1. Credit Card Debt:

   • Why: Buying clothes, dining out, impulsive shopping.
   • Interest: 36-40%.
   • Value: Zero after consumption.

2. Personal Loan for Vacation/Wedding:

   • Why: "Dream wedding" or "Euro trip."
   • Interest: 11-15%.
   • Value: Memories remain, but you pay for them for 5 years.

3. Car Loan (Debatable):

   • Why: A car loses 10-15% value the moment it leaves the showroom.
   • Verdict: Necessary evil for commute, but Bad Debt financially. Don't overspend on luxury cars.

The "Grey" Area

Sometimes, bad debt is necessary.

• Medical Emergency: Taking a personal loan to save a life. (Necessary).
• Car for Uber Driver: It's a business asset (Good Debt).
• Car for You: It's a liability (Bad Debt).

How to Manage Debt (The 30-40-30 Rule)

Banks use this to decide if they should lend to you. You should use it too.

Total EMIs should not exceed 30-40% of your In-Hand Salary.

Example:

• Salary: ₹1 Lakh/month.
• Max EMI Capacity: ₹30,000 - ₹40,000.
• If you pay ₹25k Home Loan + ₹15k Car Loan = ₹40k. Stop borrowing.

Strategies to Clear Debt

If you are drowning in bad debt:

1. The Avalanche Method (Mathematically Best)

• List all debts.
• Pay minimum on all.
• Put extra money into the Highest Interest Rate loan (e.g., Credit Card).
• Once cleared, move to next highest.
• Result: You pay least interest overall.

2. The Snowball Method (Psychologically Best)

• List all debts.
• Pay minimum on all.
• Put extra money into the Smallest Loan Amount.
• Once cleared, you feel a "Win." Move to next smallest.
• Result: Builds momentum and motivation.

Should You Prepay Home Loan?

Scenario: You have ₹5 Lakhs surplus. Home loan interest is 8.5%.

• Option A: Prepay Loan. Save 8.5% interest (Guaranteed).
• Option B: Invest in Mutual Funds. Expected return 12%.

Math says: Invest (12% > 8.5%). Peace of Mind says: Prepay (Debt-free life is stress-free).

Middle Path: If you are young, invest. If you are near retirement, prepay.

7-Day Action Plan

Day 1: List all your loans (Type, Outstanding Amount, Interest Rate, EMI).
Day 2: Categorize them into Good Debt vs Bad Debt.
Day 3: Calculate your Debt-to-Income Ratio (Total EMI / Monthly Income). Is it less than 40%?
Day 4: Make a plan to aggressively pay off the Bad Debt (Credit cards, Personal loans).
Day 5: Check if you can "Refinance" high-interest loans (e.g., switch Home Loan from 9.5% to 8.5%).
Day 6: If you have a car loan, check if you can prepay it partially.
Day 7: Vow to never take a loan for a phone or vacation again.

Quiz

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💡 Final Wisdom: "Interest on debt grows without rain." — Yiddish Proverb. Kill bad debt before it kills your financial future.