Debt is like fire. Used correctly (like a Home Loan), it can cook your food and keep you warm. Used incorrectly (like Credit Card debt), it burns your house down.
In modern society, debt is normalized. "Buy Now, Pay Later" schemes are everywhere. While leverage can accelerate wealth building, consumer debt is the single biggest destroyer of financial futures. In this module, we will learn how to distinguish between good and bad debt, manage your credit score, and execute a strategic plan to become debt-free.
1. Good Debt vs. Bad Debt
Not all loans are evil. We classify debt based on two factors: Cost (Interest Rate) and Purpose (Does the asset grow in value?).
2. The Health Check: Debt-to-Income Ratio (DTI)
Before taking a loan, banks calculate your DTI. You should calculate it too.
- 0% - 30%: Healthy. You have room to invest.
- 30% - 40%: Manageable, but avoid new loans.
- Above 40%: Danger Zone. You are working primarily for the bank. One emergency can cause a default.
3. Strategies to Kill Debt
If you are drowning in multiple loans (Credit Card + Personal Loan + Car Loan), how do you start? There are two mathematically distinct strategies.
Avalanche Method
Mathematically Optimal
Target the loan with the Highest Interest Rate first. Ignore the balance size. This saves the most money over time.
Snowball Method
Psychologically Optimal
Target the loan with the Smallest Balance first. Ignore interest rates. Clearing a small loan gives you a "Win" and momentum.
Which is better? Studies show the Snowball Method often works better because debt is an emotional problem. The dopamine hit of closing a loan keeps you motivated to attack the next one.
4. Your Financial Report Card: CIBIL Score
Your Credit Score (CIBIL in India) is a 3-digit number that determines if you get a loan and at what interest rate.
Credit Score Spectrum
Excellent Score (Lower Interest Rates)
Factors Affecting Score:
- Payment History (35%): Did you pay EMIs on time? Even one missed payment hurts.
- Credit Utilization (30%): How much of your credit limit do you use? Keep it below 30%. If your card limit is ₹1 Lakh, don't spend more than ₹30,000.
- Credit Age (15%): Older credit history is better. Don't close your oldest credit card.
5. The Magic of Prepayment
For long-term loans like Home Loans (20 years), interest often exceeds the principal amount. The bank profits massively from time.
The Hack: Prepaying just one extra EMI per year can reduce your loan tenure by 4-5 years and save lakhs in interest.
Example: On a ₹50 Lakh loan at 8.5% for 20 years:
Total Interest Payable: ₹54 Lakhs (More than the loan amount!).
If you pay 1 extra EMI/year: You save ~₹12 Lakhs in interest and finish the loan in 16 years.
6. Credit Cards: A Double-Edged Sword
Credit cards are excellent tools if used correctly (Reward points, Interest-free period, Building credit score). They are disastrous if used wrongly.
Never pay just the "Minimum Amount Due." This is usually 5% of the bill. The remaining 95% attracts interest at 3-4% per month (40%+ per annum). Plus, you lose the interest-free period on new purchases. Always pay the Total Amount Due.
Summary of Module 4
Debt steals from your future self to pay for your present self. To build wealth, you must stop the leakage.
- Stop taking new bad debt.
- Choose a strategy (Snowball or Avalanche) and attack existing debt.
- Protect your CIBIL score like it's your reputation.
- Prepay home loans aggressively in the early years.
Once you are debt-free (or have manageable good debt), you are ready to face life's risks. In the next module, we will discuss how to protect your wealth from disasters: Insurance Planning.