Chapter 4 of 10
Good Debt vs Bad Debt
Which loans build wealth and which destroy it.
Raksha's accountant sent her a 14-page report at midnight with the subject line: "FY25 Assessment."
She opened it at 7 AM between the breakfast rush and prep. She skimmed past the P&L and found the summary: her two restaurants generated ₹1.8 crore combined profit last year. She felt good for exactly 30 seconds.
Then she saw the liabilities section.
Restaurant loan 1 (taken for equipment): ₹12 lakh outstanding at 10.5% Restaurant loan 2 (taken to expand to new branch): ₹28 lakh outstanding at 11% Personal loan (taken for sister's wedding): ₹6 lakh outstanding at 16.5% Credit card outstanding (personal card used for business): ₹2.1 lakh at 36%
Total debt: ₹48.1 lakh.
She set down her coffee. Not all debt is the same. Not even close.
Good debt is borrowing that funds an asset or activity that generates returns higher than the cost of the loan. Bad debt is borrowing that funds consumption, depreciation, or expenses with no return, leaving you poorer after the cost of interest.
The Framework That Changes How You Think About Loans
Most people think: "Debt is bad. Avoid it."
That's too simple. A ₹50 lakh home loan at 8.5% to buy a property worth ₹80 lakh today (and likely ₹1.2 crore in 10 years) is not the same as a ₹5 lakh personal loan at 18% to buy a watch.
The question isn't "Do I have debt?" The question is: "What is this debt earning me versus what it's costing me?"
| Debt Type | Rate | What It Funds | Net Effect |
|---|---|---|---|
| Restaurant equipment loan | 10.5% | Asset earning 25–30% returns | Positive, good debt |
| Restaurant expansion loan | 11% | New branch generating profit | Positive, good debt |
| Wedding personal loan | 16.5% | A one-time expense with zero return | Negative, bad debt |
| Credit card at 36% | 36% | Mixed personal and business spending | Extremely bad |
Raksha's restaurant loans? Good debt. They funded assets that generate ₹1.5–2.5L/month profit per restaurant. The interest cost is far exceeded by the return.
Her personal loan and credit card? Bad debt. No return. Pure cost.
The Math That Makes Good Debt Make Sense
Raksha took a ₹28 lakh loan at 11% for 5 years to open her second restaurant.
Annual interest cost: roughly ₹3.08 lakh in year 1 (reducing over time) Average annual interest over loan life: ~₹1.8 lakh
Second restaurant's net profit per year: ₹18–30 lakh (₹1.5–2.5L/month)
Return on the borrowed capital: ₹24L profit ÷ ₹28L borrowed = 86% ROI on borrowed money
She paid 11% to earn 86%. That's financial leverage working as intended.
If she had NOT borrowed and saved up instead: she'd have waited 3–4 years to open the second restaurant, missing ~₹72–90 lakh in cumulative profits during those years.
The loan made her wealthier, not poorer.
This is why businesses borrow, not because they're broke, but because borrowed capital can generate returns far exceeding the interest cost. Banks do this every day. They borrow from depositors at 6–7% and lend at 10–14%.
Good debt passes one test: the return on what you're funding exceeds the cost of the loan.
Home loan at 8.5% to buy property that appreciates at 6–10%/year + saves rent: borderline to positive. Education loan at 12% for a course that increases income by ₹5L/year: very likely good debt. Business loan at 11% for expansion that earns 25%+ returns: clearly good debt. Personal loan at 18% for a vacation: clearly bad debt. No return.
The Quiet Killer: Credit Card Debt
Raksha's ₹2.1 lakh credit card outstanding at 36% interest is the most dangerous line in her ledger.
At 36% annual interest on ₹2.1 lakh:
- Monthly interest: ~₹6,300
- If she pays only minimums (₹5,000/month), the balance barely shrinks
- In 12 months of minimum payments: she'll have paid ₹60,000 but reduced the principal by only ₹10,000–₹15,000
Credit card debt is mathematically hostile. It compounds monthly. One bad month turns into a year of damage.
And Raksha's specific problem: she used her personal credit card for business expenses. This is the "mixing personal and business accounts" trap that makes her finances impossible to untangle.
Raksha's biggest financial mistake wasn't the debt, it was using the same accounts for personal and business. This creates:
- Tax reporting nightmares (can't claim business expenses clearly)
- No visibility into actual business profitability
- Personal credit score exposure to business fluctuations
- Personal credit card (36%) used instead of business overdraft (13–15%)
Fix: Open a separate business current account. Get a business credit card. Move all business transactions there. Keep personal finances completely separate.
The Wedding Loan Problem
The ₹6 lakh personal loan at 16.5% for her sister's wedding is textbook bad debt. It funded:
- An event that's over
- Zero financial return
- Pure ongoing interest cost
The loan isn't wrong morally. Family is family. Raksha would make the same choice again. But financially, it's consumption debt, and it needs to be paid off aggressively, not managed gently.
At 16.5% interest, every ₹1 she delays repaying costs her 16.5 paise/year. Compared to her restaurant loans at 11%, the wedding loan is the priority.
Raksha's Debt Triage Plan
She ranked her debts by interest rate, highest first:
| Debt | Outstanding | Rate | Action |
|---|---|---|---|
| Credit card | ₹2.1L | 36% | Pay fully from business profit this month. Emergency. |
| Wedding personal loan | ₹6L | 16.5% | Pay off in 4 months using profits. High priority. |
| Restaurant loan 1 | ₹12L | 10.5% | Maintain regular EMI. Good debt. No rush. |
| Restaurant loan 2 | ₹28L | 11% | Maintain regular EMI. Good debt. No rush. |
Her plan: dedicate ₹3L from next month's profit to clearing the credit card entirely. Then redirect ₹1.5L/month for 4 months to the wedding loan.
After that: zero bad debt. Only productive restaurant loans that cost less than they earn.
When "Good Debt" Turns Bad
Good debt can go wrong. The return > cost test fails when:
- Business underperforms: If the second restaurant had been loss-making, the ₹28L loan would have been devastating instead of valuable
- Interest rates rise: A floating rate loan at 10% can become 14% if RBI raises rates: check if your loan is fixed or floating
- You over-leverage: Borrowing ₹1 crore for a business that can only support ₹30L in debt creates fragility
- Cash flow mismatch: Profitable business, but monthly EMIs exceed monthly cash inflows: still a crisis
The lesson: good debt needs healthy cash flow. You need to comfortably service EMIs even in a bad month.
A general guide: total EMIs (including business and personal) should not exceed 40% of your monthly net income. Raksha's monthly profit averages ₹2L. Her total monthly EMIs should stay under ₹80,000. Check your own ratio before taking any new loan.
Borrowing Strategically: The Business Owner's Mindset
Raksha now thinks about every borrowing decision through one question: "Does the return from this loan exceed its cost?"
Education loan for professional certification: probably yes. Hire faster and earn more. Working capital loan for restaurant inventory: yes, if margins cover cost. Another restaurant branch: yes, if location and market are right. Home renovation loan for personal use: maybe acceptable, but not good debt. Pay off faster. Buying a luxury car on EMI for "status": no. Depreciating asset, no return. Bad debt.
Key Takeaways
- Good debt funds assets or activities that generate returns higher than the loan's interest cost
- Bad debt funds consumption, events, or depreciating assets with no financial return
- Credit card debt at 36% is the most dangerous: pay it fully, every month, or eliminate it fast
- Never mix personal and business bank accounts: open separate current accounts for your business
- Rank debts by interest rate: highest rate = highest priority for repayment
- Check the 40% rule: total EMIs should not exceed 40% of net monthly income
Sort Your Debt Today
Pull out your loan statements. List every debt with its interest rate. Apply the return > cost test to each one.
Good debt: maintain EMIs, don't rush to prepay if returns exceed interest. Bad debt: eliminate as aggressively as your cash flow allows.
And if you have credit card outstanding: pay it off before any investment, any vacation, any upgrade. Nothing generates 36% guaranteed returns. Nothing.
Use the EMI Calculator to see the true cost of any loan you're considering. Run the numbers before you sign.
Raksha has two debts: a restaurant loan at 11% that funds her profitable business, and a personal loan at 16.5% for a past wedding. Which should she prioritize repaying?