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Debt is a dirty four letter word to many people. Yet there are some instances where it can have a strategic use to build wealth. Whether you have high interest rates on your credit card or a car loan on a depreciating asset, debt can be both good and bad for you depending on how you use it.
Wealthy people use good debt to increase their income and bring real wealth and accomplish financial goals. When they pay the debt their long term wealth increases.
Bad debt often comes with high interest payments if not paid in full on time, and it will not enable you to create wealth for yourself.
Almost everyone has both good and bad debt. The top priority for a bright financial future is by eliminating the bad debt so that you can work toward financial success. Here are 8 ways to use debt to build wealth.
1. Consolidate Debt
In order to get your bad debt under control, it is often a good idea to consolidate all of the loans/debt you have into one payment.
What’s the value of this? Simplicity, you’ll only have to pay one loan per month.
It means taking out a personal loan with a low interest rate and using it to pay off everything else, like credit card debt. So that you can focus on paying back one manageable payment each month rather than juggling multiple payments every single month. Having to deal with multiple due dates is definitely the worst case scenario.
This can make for a really stressful financial situation for you
Use this good debt (personal loans) at a lower interest rate to pay off the bad debt.
This will help reduce stress in your life while also saving money since a consolidation loan usually charges a lower interest rate than credit cards and sometimes student loans.
Debt consolidation may not be for everyone because it doesn’t change your underlying habits or your daily financial decisions. You must work diligently to be debt free. Before you can even think about using debt to build wealth you have to begin making sound financial decisions. Eliminating bad debt and focusing on your personal objectives are important.
It’s most important to get on the right budget for your situation. This is important so you can start with a foundation so you can continue pursuing your financial goals.
Keep Reading: 20 Budgeting Tips for Beginners
Reasons Why You Might Want To Consolidate:
- Will save a lot of time and energy managing one loan and one payment, not multiple.
- Can lower interest rates on credit cards, reducing monthly payments even more.
- Allows for better financial planning since everything is in only one place (one payment due at the end of every month).
What You Should Know Before Deciding To Consolidate Your Debt:
Make sure to calculate the total interest that will be charged over time before making any decisions about whether it is worth it or not.
You want to make sure taking out the consolidation improves your financial situation.
2. Better Cash Flow Management
Managing your cash flow is key as you pay off debt.This means paying attention to how much comes in and goes out of your life so that you can eliminate unnecessary spending and find ways to optimize your income.
This means planning for large purchases such as a car or education instead of just buying them with credit cards when they show up on our doorstep (and constantly paying interest).
What You Should Know Before Trying To Improve Cash Flow Management:
You may need a budgeting app or spreadsheet in order to track what you pay every month. The more detailed, the better!
Even though this process can be time consuming at first, it will help reduce costs dramatically down the road by allowing you to catch wasteful spending before it happens. It’s best to become aware of such information as soon as possible. The value of self-awareness is priceless.
3. Utilize Lump Sums Wisely
If you have a large sum of money coming your way (for example, an inheritance or tax refund) using it wisely can help pay off debt and build wealth.
Different Ways to Use Lump Sums:
- Paying off credit card balances quickly or paying of that personal loan that consolidated the debt
- Build up a fully funded emergency fund. 3-6 months of your expenses is a good rule of thumb
- Invest in income producing assets. Real estate is an investment asset I own. The idea here is you want to find an asset that puts income into your pocket on a monthly basis
What You Should Know Before Trying To Invest Lump Sums:
Only invest into things you understand. Don’t risk anything on more investment simply because you have the money. There is an allure of increasing your net worth by putting more money in investments. Don’t let this fool you into investing into something you don’t understand.
Education is key to understanding what a good debt is and how to give yourself financial security in the future.
4. Debt Recycling
Debt recycling involves taking money which you usually put towards debt and instead of paying off your debt with it, using that to pay into a retirement account like an IRA.
How You Can Use Debt Recycling To Your Advantage:
It may be possible to get matching contributions from some employers when they deposit their own extra cash into your 401k or other retirement account. This will double the amount of money invested which is a great way to get in your debt free journey.
One drawback with this strategy is that you may not be able to access those funds for an emergency if it arises suddenly. You then may be forced to resort back to more debt on credit cards.
Therefore, there should always be some extra of your own money set aside just in case something happens unexpectedly. Life happens to all of us. Accumulating more debt or taking out another loan is not the key to building wealth.
If done correctly this can be a great way to begin building your wealth while paying off debt. Who says you can’t do both?
5. Margin Investing
Margin investing is another way to build wealth without needing too much money upfront. You can in essence borrow from the brokerage.
For example, if someone wants to buy $100 worth of stock but only has $50 available then they could borrow the other $50 from their broker instead at an interest rate until it is paid off completely.
How To Get Started:
To get started, a person must first open a brokerage account and then borrow money from it in order to purchase stocks.
When done correctly, this can help your investment work for you without needing too much upfront cash.
Again, education is the top priority. Make sure to read up on taking out a margin loan. I’ve seen stories of people who use debt to build their stock portfolios. I’ve also seen many beginner investors take on too much debt thinking they are building wealth and end up losing the wealth they had.
Only engage with more investments when you understand the pros and cons. You don’t want to lose the principal of your investment if at all possible.
6. Invest In Real Estate
Another way to make good debt work for you is by investing in residential real estate. The value of this comes from the rental income and home equity for example.
The difference between this type of investment compared to something like stocks is how much capital each trade requires since there are other expenses associated with owning land such as a home loan, property taxes, insurance, HOA fees and maintenance costs.
Keep these in mind when doing any kind of financial projections. However, once you find the right kinds of residential properties then leveraging debt can help you start with a smaller amount of your own wealth at stake. A home loan can be a good debt to have. There are many wealthy landlords who have staked their financial future on real estate and are using good debt to accomplish this.
How To Invest In Real Estate:
The first step is to talk with other investors who are already involved. Reading a blog can only take you so far.
When adding real estate to your investment portfolio you want to make sure you are surrounded by others who are growing their wealth in this way.
Debt isn’t always a bad thing. Loans can sometimes be a good investment. When used in the right ways, you can use it to build wealth, passive income streams that will net you a profit and allow you to pay off your debt more quickly.
Before taking on any debt it’s good to become familiar with the different types and listen to others who have done this successfully.