Vaani Wealth LogoVaani Wealth

Managing Debt Smartly

From credit cards and EMIs to personal loans, take control of your liabilities.

Good Debt vs. Bad Debt: Not All Loans Are Created Equal

Understanding the difference between good debt and bad debt is the first step toward smart debt management.

Good Debt

Good debt is an investment in your future that has the potential to increase your net worth or income. It helps you acquire assets that appreciate over time.

  • Home Loans: To purchase a property that can appreciate in value.
  • Education Loans: To enhance your skills and boost your earning potential.
  • Business Loans: To start or expand a business that generates income.

Bad Debt

Bad debt is typically high-interest debt used to purchase depreciating assets or for consumption. It does not generate future income and can quickly become a financial burden.

  • Credit Card Debt: Carrying a balance for non-essential spending.
  • Personal Loans: For vacations, gadgets, or lifestyle expenses.
  • High-Interest Car Loans: For a vehicle that depreciates rapidly.

The Debt Snowball vs. Debt Avalanche Method

Two popular strategies to tackle existing debt.

Debt Snowball (Psychological Win)

Focus on paying off your smallest debts first, regardless of the interest rate. This method gives you quick wins, providing psychological momentum to keep going.

  1. List your debts from smallest to largest.
  2. Make minimum payments on all debts except the smallest.
  3. Put as much extra money as possible towards the smallest debt until it's gone.
  4. Roll the money you were paying on that debt into the next-smallest one.

Debt Avalanche (Mathematically Optimal)

Focus on paying off your highest-interest debts first. This method saves you the most money in interest payments over time.

  1. List your debts from highest interest rate to lowest.
  2. Make minimum payments on all debts except the one with the highest interest rate.
  3. Put as much extra money as possible towards the highest-interest debt.
  4. Once cleared, move to the debt with the next-highest interest rate.

Golden Rules for Managing Debt

Always Pay Bills on Time

Late payments not only incur fees but also significantly damage your credit score, making future borrowing more expensive.

Keep Credit Utilization Low

Aim to use less than 30% of your available credit card limit. High utilization signals financial stress to lenders.

Read the Fine Print

Before taking any loan or EMI, understand the interest rate, processing fees, prepayment penalties, and other terms and conditions.

Avoid Taking New Debt to Pay Old Debt

This can lead to a debt spiral. The only exception is a 'balance transfer' or 'debt consolidation' loan where you move high-interest debt to a new loan with a significantly lower interest rate.