This article was originally published by Uncapped Mortgage
Generally, people think of debt as something to avoid. Debt usually means “bad” and no debt means you are better off financially. So the idea of using debt to build wealth can seem a bit dubious. Can you really build wealth using debt?
In order to answer this question, we first need to know that there are two kinds of debt. There is good debt and bad debt. And though the thought of debt being “good” seems counter-intuitive, the fact remains that some debt is actually good.
Good debt is a debt that will increase your finances over time. So something like a small business loan is good debt because you use the money you borrowed to build up your business, thus, bulking up your finances in the long run. Good debt also has a smaller interest. So while you are expanding your business with your small business loan, you aren’t paying an exorbitant amount in interests. This type of debt also allows you ample time to pay back your debt.
Bad debt is the exact opposite. This kind of debt has astonishingly high-interest rates and usually involves some form of collateral. There is also a very short turnaround time for you to pay your debt, plus interest, back. Some examples of bad debt are credit card debts, car title loans, and payday loans. A loan of $100 will have you paying back nearly the same amount in interests alone. Bad debt will sink you financially faster than a boat riddled with holes.
So now that you know the two types of debt, you can probably guess which one can be used to build wealth. The question now is “how”.
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A good way is the example stated above. Use debt to expand your business. If you do not have a business, use debt to invest. It could be in property or in various investment funds. Whatever you decide to invest in, it is important to know your risk tolerance and how much you are willing to invest.
The principle of leverage can help you out as well. Say for example you are investing 100 dollars of your own with an expected return rate of 10%. This will earn you a return of $10. If you borrowed money with an interest rate of less than 10%, you can add to your initial $100 investment and still earn from it despite having to pay off the debt you used to invest. You can diversify your financial portfolio using this strategy as well; borrow to invest in different institutions and different kinds of investments.
There are a few to consider when using debt to invest. Think of your tolerance for debt. Can you realistically pay off your monthly payments? Can you pay off that debt within the time frame or do you need more time? Consider your cash flow as well. You need to make sure that you have enough income to pay off your debt.
So the answer to the question can debt be used to build wealth is yes, you can. You just need to choose the right kind of debt, invest in the right things, and keep in mind your debt tolerance.