Debt Management
Not all debt is bad. A 3% mortgage on an appreciating asset is fundamentally different from 24% credit card debt on depreciating purchases.
The distinction matters. One builds wealth through leverage. The other destroys it through compound interest working against you.
Good Debt vs. Bad Debt
| Type | Interest | Asset | Verdict |
|---|---|---|---|
| Credit card | 15-25% | Consumption | Bad: eliminate immediately |
| Car loan | 5-10% | Depreciating | Usually bad: minimize |
| Student loan | 4-7% | Future earnings | Depends: ROI of degree matters |
| Mortgage | 3-7% | Appreciating | Usually good: leverage is reasonable |
| Business loan | Varies | Cash flow | Depends: if ROI > interest rate |
The rule: If the debt finances something that increases in value or income faster than the interest rate, it might be good. Otherwise, it’s bad.
The Priority Order
- Minimum payments on everything: Protect credit score first
- High-interest debt (>10%): This is an emergency. Attack aggressively.
- Medium-interest debt (5-10%): Pay faster than required
- Low-interest debt (<5%): Pay on schedule, invest the difference
The Math That Changes Behavior
$5,000 credit card at 20% APR, minimum payments only:
- Time to pay off: 25+ years
- Total paid: $15,000+ (3× original)
- Interest paid: $10,000+ on a $5,000 purchase
You’re not paying for that purchase. You’re paying for it three times.
The flip side—compounding working for you:
That same $10,000 in interest, invested at 7% for 25 years, becomes ~$54,000.
High-interest debt doesn’t just cost money. It costs the opportunity to compound wealth. Every dollar paid in interest is a dollar that can’t compound for decades.
Two Payoff Strategies
Avalanche Method (Mathematically Optimal)
Pay minimum on everything, then throw all extra money at the highest interest rate debt first.
Pros: Minimizes total interest paid. Fastest path to debt-free. Cons: If your highest-rate debt is also your largest, progress feels slow.
Snowball Method (Psychologically Optimal)
Pay minimum on everything, then throw all extra money at the smallest balance first.
Pros: Quick wins build momentum. Psychological boost from eliminating accounts. Cons: Costs more in total interest.
Which to choose: If you’ll stick with either method, use Avalanche. If you need motivation from quick wins to stay the course, use Snowball. A slightly suboptimal strategy you follow beats an optimal strategy you abandon.
The Debt Emergency Protocol
If total debt payments exceed 35% of gross income, or if high-interest debt exceeds 3 months’ income:
- Stop all non-essential spending. Temporary sacrifice, not permanent lifestyle.
- List every debt: Balance, interest rate, minimum payment.
- Build $1,000 mini-emergency fund first. Prevents new debt from small emergencies.
- Attack high-interest debt aggressively. Every spare dollar goes here.
- Consider consolidation. If you can get a lower rate, consolidate—but only if you won’t run up new debt.
- Increase income temporarily. Side work accelerates payoff dramatically.
Debt Consolidation: When It Works
Consolidation combines multiple debts into one, ideally at a lower interest rate.
Good consolidation:
- Credit card balance transfer to 0% APR card (pay off before promo ends)
- Personal loan at 8% to pay off cards at 22%
- Refinancing high-rate student loans to lower rate
Bad consolidation:
- Extending loan term significantly (lower payment, more total interest)
- Using home equity to pay unsecured debt (now your house is collateral)
- Consolidating without addressing the spending that created the debt
The trap: Consolidation feels like progress but isn’t unless you stop creating new debt. Many people consolidate, feel relief, then run up new balances. Now they have more debt than before.
Should I Pay Off Debt or Invest?
| Interest Rate | Action |
|---|---|
| >10% | Pay debt. Guaranteed 10%+ return beats market |
| 7-10% | Pay debt. Risk-adjusted, guaranteed wins |
| 5-7% | Split 50/50, or follow psychology |
| <5% | Invest. Market likely outperforms |
But also consider:
- Tax deductibility: Mortgage interest deduction effectively lowers the rate
- Psychology: Some people need the peace of being debt-free
- Liquidity: Investments are accessible; equity in a paid-off house isn’t
- Employer match: Always capture 401k match before extra debt payments—that’s 100% return
Decision Framework
Should I take on this debt?
- Is the interest rate below 7%?
- Does it finance an appreciating asset or higher income?
- Can I comfortably make payments at 35% of income or less?
- Do I have an emergency fund first?
- Have I calculated the true total cost over the loan term?
If any answer is no, reconsider.
Negotiating Existing Debt
Credit cards: Call and ask for a lower rate. Especially effective if you have good payment history. “I’ve been a customer for X years with on-time payments. I’d like to request a rate reduction.” Success rate: ~50%.
Medical bills: Almost always negotiable. Ask for itemized bill first (often reveals errors). Request payment plan or hardship discount. Hospitals often have financial assistance programs.
Collections: Can often settle for 25-50% of original balance. Get agreement in writing before paying. Know that settled debt may be taxable as income.
Preventing Future Debt
Paying off debt without addressing root causes guarantees future debt.
Common root causes:
- Income/expense mismatch: Spending exceeds earnings. Solution: budgeting
- No emergency fund: Every emergency becomes debt. Solution: Build Emergency Fund
- Lifestyle inflation: Raises become spending, not saving
- Emotional spending: Shopping as coping mechanism. Requires different intervention.
The rule: Before any large purchase, wait 72 hours. Most impulse purchases won’t survive the waiting period.
Success Metrics
- Debt-to-income ratio: Total monthly debt payments ÷ gross monthly income. Target: <35%
- High-interest debt: Should be $0
- Payoff trajectory: Know your debt-free date
- New debt: Only strategic debt (mortgage, education with clear ROI)
The Psychology of Debt
Debt carries psychological weight beyond the numbers. Financial stress affects health, relationships, and cognitive function (Housel, 2020).
What helps:
- Track progress visually. Seeing the number decrease maintains motivation.
- Celebrate milestones. Paid off a card? Acknowledge it (without spending).
- Talk about it. Financial shame keeps people stuck. Community helps.
- Focus on what you control. Can’t change past decisions. Can change future ones.
Objective
Eliminate high-interest debt and use low-interest debt strategically. The goal is a debt-to-income ratio below 35%, zero high-interest debt, and a clear payoff trajectory with a known debt-free date.
Cadence
- Monthly: Make all payments; throw surplus at highest-priority debt
- Quarterly: Review progress; recalculate payoff timeline
- Before any new debt: Run the 5-question decision framework (Section: Decision Framework)
- Annually: Negotiate rates on existing debt; review consolidation opportunities
KPIs
| Indicator | Type | Target | How to measure |
|---|---|---|---|
| Debt-to-income ratio | Leading | <35% | Total monthly debt payments ÷ gross monthly income |
| Extra payments made | Leading | Consistent monthly surplus applied | Bank statements |
| High-interest debt balance | Lagging | $0 | Sum all debt >10% APR |
| Payoff date known | Lagging | Yes, with specific date | Calculator or spreadsheet |
| New bad debt created | Lagging | Zero | No new consumer debt |
Failure Modes
| Problem | Fix |
|---|---|
| Only making minimum payments | Every dollar above minimum goes to highest-rate debt |
| Consolidating without behavior change | Address root cause (budgeting, emotional spending) before consolidating |
| Using home equity for unsecured debt | Never put your house at risk for consumer debt |
| Ignoring debt psychology (shame spiral) | Track progress visually; celebrate milestones; talk about it |
| Paying off low-rate debt instead of investing | If rate <5%, invest the difference; guaranteed return only beats market above ~7% |
| Lifestyle inflation after payoff | Redirect freed-up payments to investing, not spending |
Related
- Prerequisite: Build Emergency Fund ($1,000 mini-fund before aggressive debt payoff)
- Next step: Automate Investing (invest after high-interest debt is gone)
- Concept: Compound Interest (works against you in debt, for you in investing)
- Concept: Cash Flow Principle (budgeting prevents future debt)
- Anti-Patterns: Wealth Anti-Patterns (common debt mistakes)