Module 5: Debt Strategy

The Truth: Most Debt is Bad Debt

Financial gurus love to talk about "good debt" and "bad debt."

Here's the simple version:

Bad Debt: Borrowed money for things that lose value or don't generate income

• Credit cards (18-25% interest)
• Car loans on depreciating vehicles
• Personal loans for vacations or stuff
• Payday loans (300%+ interest - never, ever use these)

Maybe-OK Debt: Low interest, for assets that may appreciate

• Mortgage (3-7% interest, house might appreciate)
• Student loans (if degree = higher income)
• Business loans (if business is profitable)

The Interest Rate Test

Above 10% interest: Pay it off aggressively. This is expensive.

7-10% interest: Pay it off steadily while building savings.

Below 5% interest: Minimum payments while investing extra might make sense.

Below 3% interest: Minimum payments. Inflation is eroding this debt.

Debt Avalanche (Math Winner)

Strategy: Pay off highest interest rate debt first

Why: Saves the most money on interest

Best for: People motivated by numbers and optimization

Example:

• Credit Card A: $5,000 at 22% → Pay this first
• Credit Card B: $3,000 at 18%
• Car Loan: $10,000 at 5% → Pay this last

Debt Snowball (Psychology Winner)

Strategy: Pay off smallest balance first

Why: Quick wins build momentum and motivation

Best for: People who need psychological wins to stay motivated

Example:

• Credit Card B: $3,000 at 18% → Pay this first (smallest balance)
• Credit Card A: $5,000 at 22%
• Car Loan: $10,000 at 5% → Pay this last

Which One Should You Use?

Use Avalanche if: You're disciplined, motivated by saving money, and can stay focused on a 3+ year payoff plan

Use Snowball if: You need quick wins to stay motivated, have struggled with debt before, or feel overwhelmed

The real answer: The best method is the one you'll actually stick to. Snowball costs more in interest but has higher completion rates.

The Decision Framework

Always pay off first:

• Payday loans (300%+ interest)
• Credit cards (18-25% interest)
• High-interest personal loans (10%+ interest)

No investment consistently beats 18-25% returns. Pay these off aggressively.

The Gray Zone (5-10% Interest)

Here's where it gets nuanced. Consider:

• Math says: If you can earn 10% in index funds and your debt is 7%, invest the difference
• Reality says: Stock market isn't guaranteed. Debt payoff is a guaranteed "return"
• Compromise: Split 50/50 - pay extra on debt while building investments

Low Interest Debt (Under 5%)

Examples: Some mortgages, federal student loans, 0% promotional financing

Strategy: Make minimum payments, invest the rest

Why: Inflation erodes this debt. 3% debt during 4% inflation means you're making money by having debt.

Caveat: Only if you actually invest the difference. If you'll spend it, pay off the debt.

The Priority Order

1. Build $1,000 emergency fund
2. Get employer 401(k) match (free money)
3. Pay off high-interest debt (>10%)
4. Build 3-6 month emergency fund
5. Pay off medium-interest debt (5-10%) or invest (your choice)
6. Invest heavily while making minimums on low-interest debt (<5%)

What is Debt Consolidation?

Taking out one new loan to pay off multiple debts. Goal: Lower interest rate or simpler payments.

When It Helps

• You can get a significantly lower interest rate (5%+ lower)
• You have multiple high-interest debts
• You need to simplify to one payment
• You won't rack up new debt on cleared cards

Good example: Consolidating $20,000 in credit card debt (22% APR) into a personal loan (10% APR)

When It Hurts

• You pay off cards then immediately use them again (now you have MORE debt)
• Consolidation loan has hidden fees that negate savings
• You extend the term so much that you pay more total interest
• You consolidate low-interest debt into high-interest debt

Bad example: Taking a home equity loan (risking your house) to pay off unsecured credit cards