Did you know that around 66% of Americans can’t pass a financial literacy test? In fact, a FINRA study revealed that millennials especially (76% !) struggle with financial literacy. A lack of financial awareness can lead to engaging in problematic financial behaviors such as taking on too much debt.
However, it’s important to know that not all debt is bad debt. This year for National Financial Awareness Day, we’ll talk about the difference between good and bad debt and how you can leverage debt to make money and build wealth.
Understanding The Difference Between Good and Bad Debt
Most people look at debt through the lens of the interest rate, how they are charged, and their ability to pay it back. But there’s one more critical aspect to consider, and that’s how you plan on using the money being borrowed. You see, good debt is basically the money you borrow to purchase an asset that increases in value over time. Income derived from such assets can be used to repay the accumulated debt. Common examples of good debt include:
- Business loans
- Student debt
Bad debt, on the other hand, is money borrowed for the purchase of assets that cannot generate income and do not increase in value over time. Some common types of bad debt include payday loans, credit card debt, and high-interest loans. So, in a nutshell, if you want to leverage debt to make money, you would use the money you borrow to acquire assets that generate income.
“Rich people use debt to leverage investments and grow cash flows. Poor people use debt to buy things that make rich people richer.”
~ Grant Cardone
How To Leverage Debt To Build Wealth
Now that you know the difference between good and bad debt, let’s look at how you can leverage debt to make money. Individuals who are capable of using debt to build wealth can find loans that have low-interest rates allowing them to have more assets. The idea behind using debt for building wealth is to increase the returns on borrowed capital. Some ways to leverage debt to make money include:
Create a debt repayment plan
The very first thing you need to do if you want to use debt to build wealth is determine how you’re going to pay off that debt. When it comes to debt repayment plans, there are two methods you can use to expedite paying off debt: the snowball method or the avalanche method.
The snowball method means that you’ll start by paying off your smallest debts first and work your way up to the larger ones. Using the avalanche method allows you to start by paying off the debt with the highest interest rate first. It’s better to start with the snowball method, as it helps build momentum, and then use the avalanche method to tackle high-interest debts.
Use debt to learn
Student loans are generally categorized as good debt because they allow you to learn marketable skills and can help you start your career on the right foot. However, it’s important to understand that such debts are not risk-free.
Before taking on student loan debt, it’s advised to research your ideal career or profession. The goal here is to determine whether your dream job will allow you to pay off the debt and support your lifestyle. In addition, you also need to ensure that job opportunities in your chosen profession are sustainable and don’t come with a glass ceiling that can limit your income.
Start a business
The average cost of starting a business in the United States (US) can be anywhere between $30,000 to $40,000. Now most people might not have the required capital needed to launch their own startup. But that’s where good debt comes in.
Taking out a business loan is a feasible approach to leverage debt to make money. You can use the initial capital to start your business and then use the business earning to pay off the debt. However, before you take out a business loan, you must do extensive research and determine whether your business idea is feasible or not.
Buy real estate
If you’ve been paying off your loans on time, chances are you probably have good creditworthiness. Lenders are more likely to give you mortgages at lower rates if you have a good track record of paying off money. This means that you can possibly afford to buy real estate comparatively easier than others.
However, when acquiring properties with the goal of leveraging debt, remember that the asset you purchase should allow you to generate income and appreciate in monetary value over time. When you leverage debt to buy real estate, you can create a source of sustainable passive income and help you reach your wealth goals. It goes without saying, but you must do extensive research before buying real estate for any investment purpose.
The Bottom Line
To use debt to build wealth, some basic financial awareness about the difference between good and bad debt is important. Good debt is capital you use to acquire assets that generate income. Bad debt, on the other hand, is money used to buy assets that depreciate over time. Using debt to invest, start a business, and acquire real estate are some ways to leverage debt which can help build wealth. Contact us today and learn more about how we can help you build and manage your wealth.