Good vs. Bad Debt
Whether a debt is “good” or “bad” depends on two main factors: the interest rate and the purpose of the borrowing.
Good Debt
Good debt is usually low-interest and tied to an asset, something that can increase your long-term financial well-being.
Some examples:
Mortgages
A mortgage is a loan from the bank that helps you purchase a property without needing the full amount in cash upfront. The idea is that property values generally increase over time, but your loan amount stays the same, so you gain all the upside. The mortgage repayments may also be comparable to what you would pay in rent, so instead of paying rent to someone else, you can use the same money to own a property for yourself.
Over time as you make monthly repayments, your mortgage balance will gradually decrease until it’s fully paid off, leaving you debt-free while still owning the property outright. If the property price goes up, you could also gain significant equity (property value less mortgage amount) and be in a stronger financial position than if you were renting.
The risk is if rising interest rates increase your monthly repayments, you need to pay unexpected maintenance costs, or the property price doesn’t increase or drops, then this could leave you financially worse off than renting.
Student Loans
Student loans are funds borrowed to pay for tertiary education, with the expectation that obtaining a degree will boost your earning potential. It’s important to use student loans wisely, choosing courses and career paths that offer enough earning potential to comfortably manage the loan repayments later on, or you risk ending up without a job and a debt you can’t repay.
Business Loans
Borrowing to start or expand a business can be an effective way to generate income and build growth. However, banks typically only approve business loans when there’s a proven track record of profitability (minimum 2-3yrs operations), giving them confidence that repayments can be made from the business’s cashflows. For less profitable or newer businesses, lenders often require a Personal Guarantee from the business owner, a director of the business, or an established individual, who agrees to personally repay the debt if the business cannot. Because of this added risk, it’s crucial to borrow only what the business truly needs to grow, as a business failure would leave the guarantor liable to repay the loan and face serious financial consequences if they cannot.
Bad Debt
Bad debt typically involves high interest rates and is used to purchase things that don’t add long-term value or depreciate quickly. It often funds lifestyle choices or impulse purchases and can easily spiral out of control if not managed.
Examples include:
Credit Cards
Credit cards often come with interest-free periods and perks like discounts or reward points to encourage spending. While these benefits can be useful if the full balance is paid on time, any unpaid amount after the due date typically incurs very high interest rates, often over 20%! If left unpaid, this interest can compound exponentially, making the debt grow quickly and potentially become unmanageable.
Personal Loan
In Hong Kong, banks often promote personal loans directly to individuals. This is not free money given by the bank. It comes at a cost, typically shown as an APR (Annualised Percentage Rate), which includes both interest and associated fees, giving you a clearer picture of the true cost. Even if the APR appears low, it is still an extra financial burden. Before accepting a personal loan, ask yourself, “What am I using this money for?” If the loan is intended for something that doesn’t improve your financial situation, like non-essential spending, it’s usually wiser to decline.
Car Loans
Taking out a loan to buy a car may feel like a good idea at the time, but it can become a significant financial strain. Cars depreciate value quickly, not to mention ongoing expenses like maintenance, insurance, fuel or charging costs, and parking fees. If a car is essential for your work or income, consider more affordable options like a less expensive vehicle that you can realistically save for, so you can avoid taking on an unnecessary debt.
Debt Repayment Strategies
If you already have existing debt, especially high-interest debt, it’s important to create a plan to pay it off quickly.
Here are some effective methods to consider:
1. Cut Expenses to Free Up Cash
One of the most immediate and effective ways to pay back debt faster is by reducing your everyday expenses. The less you spend, the more money you can use to pay off what you owe.
Start by reviewing your spending habits. You can use our Expense Tracking guide to help. Go through your spending and identify areas where you can cut back, especially for non-essentials like dining out, subscription services, entertainment, or impulse purchases. Even small changes like bringing lunch to work can add up over time.
Once you’ve identified where you can cut back, create a budget that prioritises debt repayment. See our Budgeting guide. The money you save can then be reallocated directly toward your debt to pay it off more quickly and reduce the amount of interest you’ll pay overall.
2. The Snowball Method
This method is designed to keep you motivated by focusing on clearing the smallest debts first. It gives you a psychological boost as seeing debts disappear early on can give you a sense of progress and accomplishment. This can be especially helpful if you’re feeling overwhelmed. The small wins build confidence and gives you the assurance to keep going until you become debt free.
Start by listing all your debts in order of smallest to largest balance, regardless of the interest rate. While continuing to make minimum payments on all your debts, you put any extra money toward the smallest debt first. Once that debt is fully paid off, take the money you were using to pay it and “roll” it into the next smallest debt. With each debt you fully repay, the amount you can apply to the next one grows, like a snowball rolling downhill.
Example
You have 3 outstanding debts, in order of smallest to largest amounts due:
- Debt A – HK$1,000 due with minimum monthly repayment of HK$200
- Debt B – HK$3,000 due with minimum monthly repayment of HK$300
- Debt C – HK$10,000 due with minimum monthly repayment of HK$500
Every month you have total of HK$1,500 for debt repayment, meaning after you meet the minimum repayment amounts for each debt, you still have HK$500 left. This is allocated to repay the smallest debt, i.e. Debt A, so your monthly repayment to Debt A is actually HK$700. Once Debt A is fully repaid, you will have HK$700 to allocate to Debt B, so Debt B’s monthly repayment increases to HK$1,000, and so on. As this process continues, you can repay more and more over time, and debts are cleared more quickly.
3. Avalanche Method
This strategy focuses on efficiency and saving money over time. Instead of paying off the smallest debt first (as in the snowball method), this approach prioritises the debt with the highest interest rate, regardless of its balance.
The main advantage of the avalanche method is that it helps you pay less interest overall, so you can get out of debt faster and cheaper in the long run. However, because high-interest debts often have bigger balances, it may take longer to pay back the first one, which can feel discouraging. That’s why this method works best for those who are motivated by numbers and long-term savings, rather than quick wins. It requires discipline and patience but delivers the biggest financial benefit in the end.
To start, list all your debts by interest rate, from highest to lowest. Continue making the minimum payments on all debts, but put any extra money toward the one with the highest interest rate. Once that is fully paid off, move on to the next highest rate, and repeat the process.
Example
If you have a credit card debt of HK$10,000 with a 25% annual interest rate and a personal loan of HK$3,000 with 10% annual interest rate, you’d focus on aggressively paying off the credit card first, even if the personal loan has a smaller balance. This is because high-interest debt grows faster, meaning you’ll pay much more in interest over time if it’s left to continue for longer.
4. Debt Consolidation
This method involves combining multiple debts, such as credit card balances, personal loans, or other loans, into a single loan, ideally with a lower interest rate. This can simplify your monthly payments, reduce the total interest you pay over time, and make it easier to manage your debt. Having only one loan instead of several can also make budgeting easier and lower the risk of missing payments.
When considering loans for debt consolidation, make sure to compare interest rates, fees, repayment terms, early repayment conditions, and the lender’s reputation. It’s also important to check whether the total repayment amount over time will actually be lower than what you’d pay by continuing with your current loans. In some cases, a lower monthly payment spread over a longer period can end up costing more overall, but it might still be a practical option for someone who doesn’t have enough money to meet their current repayment obligations.
Final Tip
Always be clear about why you’re borrowing money. If it doesn’t support your long-term goals or improve your financial situation, don’t take on the debt. It’s far easier to stay debt-free than to dig your way out of debt. If you find yourself repeatedly accumulating bad debt, take a step back and honestly examine the habits and spending patterns that are leading you into debt. Staying debt-free means making intentional choices and smarter financial decisions that align with the future you want to build.