All our lives we have been told debt is terrible thing, and that we need to avoid it at all costs. People like Dave Ramsey preach this, and many take his advice and wisdom as non-negotiable fact. While Dave’s advice works for many circumstances in which American’s currently find themselves struggling with when it comes to debt, the truth is much more than people like Dave let on. Debt, when used correctly, is the most powerful tool for wealth and financial freedom that there is. To understand this, we must first dive a little deeper to distinguish different types of debt and how they fit into society today.
bad debt is a mindset
Credit Cards:
This type of debt is what most people accumulate and work their whole lives to pay off. However, the debt is not the problem in this scenario, it is the mindset of the person who is accruing said debt. The most common form of debt today is credit card debt. So many people get credit cards and spend money they don’t have on things they don’t need. This is because buying things with a credit card is not as painful as handing cash over to someone else, or even seeing the account balance go down in your bank account. I am not suggesting that you should only pay cash or debit for purchases, however the use of credit cards for people with the wrong mindset is dangerous because it can trap people underwater seemingly forever. In order to properly use a credit card, you must first understand your own spending habits, what your income looks like, and what you truly need to sustain your quality of life. If you ask yourself these difficult questions and keep track of your financials, you are almost guaranteed to instantly make better financial decisions right off the bat. Something most people don’t realize when it comes to credit cards is the extremely high interest you pay on your debt if you let it accrue. Credit cards regularly charge interest rates upwards of 20% or even sometimes 30%! That is basically taking on an additional 20%-30% of what you spend on a yearly basis and flushing it down the toilet if you don’t use credit cards correctly! In reality credit cards have tons of benefits if you understand them and use them responsibly. For instance, many cards offer benefits right off the bat such as sign-up bonuses and rewards when a certain amount of money is spent after opening a new card. Perhaps the most amazing benefit of being a savvy credit card user is being able to strategically accumulate and gain points from cash back rewards. Most credit cards offer cash back on purchases and certain cards have certain benefits for different types of spending. For example, one card may advertise that they offer 5% cash back for all travel purchases or 3% for gas. Over time, this can help you recover a lot of money which can then be exchanged for cash or other rewards such as travel, vacations, dinners, and so much more!
College Education:
I have ranted on this blog many times about how I dislike the college system, but I feel as though it has its place to be expanded upon in this blog post. When you go to college, unless you have a very specific career path and degree in mind you should not be throwing 100 grand plus in debt at a college degree you may or may not use!!!! So many people are taking out mortgage-sized loans before they even start working to get a degree in something they’ll never need just to say they went to college! This is terrible debt and could set you back decades if you choose to go down this path.
Housing:
Now, this topic may be a little controversial when it comes to debt, however let me explain the opportunity leveraging debt presents in terms of housing and homeownership in America. To circle back to what I was mentioning before about Dave Ramsey, his conventional wisdom states that we should pay off our homes in full as soon as we can so we don’t have the overbearing pressure of paying our mortgage every month for years to come. While this sounds like a solid idea at first, let’s break this down further to see what the opportunity cost is of using all your extra money to pay down your mortgage at higher-than-normal rates. First and foremost, if you are paying a fixed-mortgage rate (likely 2.5%-4.5%), putting your money elsewhere that will grow your money faster than the 2.5%-4.5% range will net you exponentially more money over time. For example, the average appreciation of the stock market is 8% a year when given time to go through its peaks and valleys. This is more than double the interest rate on your house therefore outpacing your interest and making you double the money over the 30-year duration of your home loan (assuming you take a 30-year loan, the same rule applies no matter the loan duration as this is just an example). The debt on your home allows you to keep your cash liquid to invest elsewhere and get a better return over time than you ever could have saving money and paying down your mortgage more so than required.
Leveraging Debt In Real Estate Investing
Almost everyone savvy in the financial community agrees that real estate is an amazing asset to add to your portfolio as a wealth builder over the course of time. However, what differs is the way that people choose to invest in terms of debt accumulation. The Dave Ramsey types will buy a home in all cash, as they believe that taking on debt will increase their risk in their investment. While there may a small amount of truth in this, the fact of the matter is not many people have enough cash lying around to purchase a house in full. In addition to this fact, there are many great ways to leverage debt to scale your real estate portfolio at an extreme pace that the traditional route does not permit. One of these methods is called the BRRRR strategy, or buy, rehab, rent, refinance, repeat. The amazing thing about the BRRRR strategy is that it can be done using none or little of your own money, and at the same time grow your real estate portfolio massively in a relatively short period of time. The BRRRR strategy works best with distressed properties that need work and require renovation, so finding a good deal is vitally important. To acquire a property, you can generally use someone called a hard money lender whose sole purpose is to give out short-term loans for people looking to BRRRR and flip. These loans are typically 6–12-month loans, have a high interest rate of 10%-12%, and sometimes deal with points (added amounts of interest payments aside from what is accrued on the loan). These loans usually require 20% down or sometimes less and can typically be negotiated based on your situation, experience, and the deal itself. If you don’t have the 20%, bring in a family member, friend, or partner who does and have them pay it for you in exchange for a stake in the deal. Most hard money lenders will fund your whole rehab as well, so you usually won’t have to pay out of pocket for this unless you choose to. You will then rehab the property thereby increasing the value of it through “sweat equity”. Assuming you did your numbers correctly in the beginning of the process, you will be able to refinance your property with a bank for a much lower interest rate on a 30-year loan and recoup your initial investment and then some in best case scenarios in which you will be able to pay all your hard money and other debts and keep the rest for yourself. You will then be able to put a tenant or a few in the property and collect rent that covers the mortgage amount and expenses, leaving whatever is left over from the rent to you in the form of cashflow. The best part about BRRRR is that with these methods it could be repeated over and over again with relative ease and none of your own money. If you’re looking for an all-inclusive guide to BRRRR, I recommend the BRRRR Book by David Greene in which he goes into massive depth on the topic.
Embracing good debt
As you can see, the use of debt is a powerful thing if used in the right way. In Spider-Man, Uncle Ben is the character who teaches Peter Parker (Spider-Man) that “with great power comes great responsibility”. To frame this to our conversation, I will add the word debt before power because the power debt holds is great, but without responsibility, knowledge, and accountability, debt will do you much more harm than good. Understand that misuse of debt could get you into deep water quickly, but on the flip side proper use will catapult you towards wealth. Choose wisely!