Debt could help us, or ruin us. Here are my 3 tips on debt.
Good Debt vs Bad Debt
- Debt means you owe someone else’s money, but what makes one debt better or worse than the others? There are a few factors determining if a debt is a good or bad debt:
- Interest rate: if the interest of the debt is higher than risk-free interest (let’s say 4%), it is most likely NOT a good debt.
- Loan structure: don’t only look at the current interest itself, is the debt on fixed interest or floating interest, how long is the debt, is it simple interest or compound interest? Do the math before you take up the loan.
- Purpose: if the debt is for consumption (e.g. credit card loan or car loan) it’s most likely NOT a good debt, as it will not help you accumulate wealth in any way, it will even make you poorer quickly; if the debt is to help you grow your wealth and wellbeing (e.g. education loan, housing mortgage) it will most likely help you in the long run.
Debt Snowball vs Debt Avalanche
- There are two camps of approaches when paying off debts.
- ‘Debt snowball’ refers to making the minimum payment on all debts and using extra funds to pay off the smallest debts first before moving to bigger ones. This creates a physiological momentum and is easy to implement.
- The debt avalanche method refers to making the minimum payment of all debts and using extra funds to pay off the debt with the highest interest rate. This is the mathematically smartest method but takes commitment to implement.
Debt-free before the FIRE phase
- When should you pay off all your debt? My own philosophy is to go debt-free by the end of your accumulation phase so you have total peace of mind going to semi or full retirement and enjoy financial independence. This might not be the most economical way, but do you still want to worry about mortgage payments, and interest rate changes, when you are no longer working full-time? What if you have some financial emergency and can’t afford to pay off the debt in time? Do you want that stress? The core of financial freedom is ‘independence’, debt-free gives you freedom.
好债务 和 坏债务
雪球还债法 和 雪崩还债法
For other topics on financial intelligence, you can find it here https://nickandmoney.com/category/fi/
Follow me on Twitter: https://twitter.com/nickandmoney
nick and money – improve your finances and wellbeing