Debt, the four letter word that sends shivers down the spines of most Americans. From a very young age we have been programmed to think one thing about debt, DEBT EQUALS BAD!!! For our entire lives we haven’t questioned this philosophy…until now. You see, there are two kinds of debt. There is good debt and there is bad debt and they are vastly different from one another. While of course maxing out your credit card at the mall on clothes would be considered bad debt, that isn’t the only kind of debt that is out there. Before we talk about the good, let’s break down the ugly side of debt. The part we’ve all been warned about and have feared for our entire lives. The truth is with financial literacy and a little discipline combined with good choices, bad debt is extremely avoidable. Ironically, staying out of bad debt can help you secure good debt! More on that later, for now, it’s on with the bad debt!
Breaking down bad debt
We all know the most common forms of debt. Credit card debt, student debt, car loan debt, etc. The truth is any sort of debt is bad if you put yourself in a position in which you won’t be able to pay off the debt. People do this by using debt to buy liabilities. Examples of liabilities include but aren’t limited to unnecessary shopping sprees, buying the most expensive car because “you can afford the monthly payments”, and taking out tens of thousands of dollars in student loan debt to obtain a useless degree! The truth is, bad debt comes from bad decisions and then festers due to the denial that those decisions were bad ones. Let’s take a closer look to see why each of these examples qualifies as bad debt.
Credit card debt
This one is pretty self-explanatory! If you spend your entire spending limit on your card on a shopping spree, that is a great way to accrue bad debt at a high interest rate for products that are liabilities instead of assets. To reiterate from before, liabilities are things that don’t make you money as opposed to assets that do. Of course in your life you will need to go clothes shopping or maybe you may want to even treat yourself. That doesn’t mean go out and buy a $2,000 Gucci bag when you have $3,000 in your bank account! Not only are you spending 2/3s of what you can cover but you’re doing it in high interest debt which can range from 20%-30% and higher! This is a surefire way to become and remain broke for the rest of your life. Getting in this kind of debt is a mindset issue that making more money won’t fix. You’ll need to develop discipline and self control if you are ever to break this bad habit.
Car loans
When most people go to get a car, they want to look flashy. They want to look rich instead of being rich. This is why they’ll choose to spend $600 or more a month on a Mercedes-Benz lease for an liability that loses its value over time as you use it. To top it all off, when you lease a car you won’t even end up owning it in most cases! Buying a car should be about what makes sense for you and your family financially, not what you think will impress others. If you want to actually be able to afford a Mercedes-Benz one day, pick up savvy financial habits now so you can own one worry-free in the future!
Student loan debt
This one may not be so obvious to some but it is by far one if not the biggest debt problem we have in our country today! Student debt in the United States right now is upwards of $1.5 TRILLION and climbing! “Well college is an investment in my future and I have to go”, you might say. My response, not for a degree that has no application in the real world. These majors include but are not limited to art, gender studies, liberal arts, and any other degree without a clear direction. People who end up falling into this trap get themselves into $100,000 of bad debt and end up graduating college to work at the local Starbucks that they could’ve worked at in high school. Don’t go to college if you don’t have a plan! This may be one of the worst financial decisions you ever end up making in your life!
Good debt
Now, let’s get to the brighter side of things! There is a light at the end of the tunnel and that light is good debt. Quite simply, good debt is any debt you take on that allows you to acquire an asset that pays you a return on your money.
Real Estate
There are so many avenues you can take when dealing with good debt, perhaps none more important and savvy than real estate. When investing in real estate, you have the ability to borrow money from banks and lending institutions to purchase properties, build equity with loan paydown, benefit from appreciation, and cash flow a net profit every month while you wait for all of that to happen! As long as you underwrite the deals you buy properly, taking on debt for those deals will make you exponentially richer over time! As long as your rent covers the mortgage payment and has some money left over for you to keep at the end of the month, you’ve essentially just bought yourself a new stream of income with debt!
Business Loans
There are many other ways to use debt strategically as well. Business loans are another example of this wherein you can borrow money from institutions to put money to work on your business plans. Obviously, this is a bit more risky than real estate investing because there is no proven asset, however a cash influx can really help a business grow and expand quicker. When you are able to strategically and carefully use business loans to scale, this is another great way to strategically use debt to increase your returns.
Gain access to good debt by limiting bad debt
As foretold in the beginning of this article, reducing your exposure to bad debt actually increases your ability to capitalize on good debt. Typically, lenders want to see how well you balance your debt and they can do this by looking at your credit score. The better credit score you have, the more money institutions will lend you, the better terms you’ll get, and the more assets you can buy!
This is just the surface of what you can unlock with using debt as a strategic asset rather than a dangerous flaw. In my experience, raising private capital from other investors and using institutional debt has served me very well in being able to acquire cash flowing assets without using any of my own funds! Get creative but remain smart and vigilant. Understand debt for the benefits and pitfalls it can cause and make smart decisions where it is concerned.