Debt management is a crucial part of personal finance. The key to successful debt management is simple: don’t spend more than you earn. However, not all debt is created equal. There are different types of debt, each with its pros and cons.
Good debt is usually a debt that is necessary to generate income or build your net worth, such as student loans and mortgages. These debts help you increase your earning capacity and asset accumulation. Good debt typically has interest rates of 1% to 4%. Instead of paying full university fees and a house upfront, the freed-up cash flow can be invested elsewhere with a higher return rate.
Bad debt, on the other hand, is usually a debt that is used to buy something that decreases in value. For example, car loans. New cars lose around 10-30% of their value once driven out of the showroom. It’s better to save up to buy a used car where the majority of its depreciation has already occurred or to pay a bigger down payment for it.
Neutral debt includes buy now, pay later (BNPL), 0% instalment plans, and credit cards. These loans are becoming increasingly popular in Malaysia. If used responsibly, they can free up your cash flow and help you save with cashback. However, if you spend beyond your means and only make the minimum payments, you could rack up huge amounts of debt with an interest rate of up to 20%.
Once you have a handle on the different types of debt and how to manage them, you can start focusing on investing. Investing is a way to grow your wealth by putting your money into assets that have the potential to earn a return. By having a long-term perspective and diversifying your portfolio, you can set yourself up for financial success and achieve your goals.