Most of the messages around debt advise you to avoid it or to pay it off as quickly as possible. While this is generally solid advice, there is such a thing as “good debt.”
Good debt is debt you take on with the goal of making more money and improving your financial future. This article explains how you can use debt to make money and the difference between good and bad debt.
Can You Use Debt To Get Rich?
It may seem counterintuitive, but you can use debt to get rich.
For instance, you can take out a mortgage and use it to purchase a property you can rent out for income. You can use the monthly rent to pay off your mortgage while building equity in the home. If the property appreciates, you can also profit when you sell it.
Of course, debt wouldn’t have such a bad reputation if it didn’t come with risk. Any time you take on debt, there’s potential for loss. Just because you purchase a house with the intention of renting doesn’t guarantee you’ll make money. The housing market can change unexpectedly, and you could end up losing money.
Before taking on any debt, it’s important to consider how much it will cost. Carefully review the interest rate and any associated fees. Having a strong credit score, steady income, and low debt-to-income ratio can increase your chances of qualifying for a better interest rate and terms.
Can You Use Debt To Invest?
You can use debt to invest. You can borrow money with the goal of purchasing investments that create larger returns than what it costs to borrow.
For instance, if you’re able to borrow money at an interest rate of 5%, and you expect to make 10% on your investments, you stand to make a profit of 5%.
However, it’s difficult to predict how an investment will perform. While there’s potential to make money, there’s also potential to lose it all, and you’ll still have to repay your loan with interest.
Before borrowing money to invest, make sure you understand the risks and only borrow if you can afford to pay your debt, even if your investment doesn’t make money.
How To Use Debt To Make Money?
There are several ways to use debt to make money; however, these strategies are often complex and require a certain level of financial knowledge, experience, and risk tolerance.
Margin Account
A margin account is a type of investment account that allows you to borrow money from the broker to invest in stocks or other financial products, while also using some of your own money.
For instance, if you have $1,000 of your own money in your margin account, you might also borrow another $1,000 so you can purchase even more shares of a stock.
If your stock choice performs well, there’s potential to double your earnings. However, if the stock decreases in value, you risk losing your money, and you’ll still have to repay the money you borrowed with interest.
Short Selling
Short selling is another strategy that experienced investors use to try and make money using debt. Investors may decide to short-sell security if they think the price of the security is going to drop.
To short-sell an investment, you need to have a margin account with the brokerage. You borrow securities from the brokerage and then sell them to a willing buyer, knowing that you have to repay the money.
If the stock price drops, you can rebuy the stocks at a lower price than you sold them for and repay the brokerage. You get to keep the profit you made from selling at a higher price.
Of course, if you guess wrong and the stock goes way up, you then have to pay the brokerage back at a higher price and will lose money.
Leveraged Buyout
Leveraging is when you use borrowed capital to try and increase the returns on an investment.
One example of leveraging is a leveraged buyout. This is when investors purchase a majority interest in a company using a large amount of borrowed money.
In a leveraged buyout, investors will typically look for a stable, predictable company to purchase. The next step is to borrow money from banks and other lenders.
Once the investors acquire the company, they look for ways to grow the business and reduce costs to increase cash flow, pay off their debt, and turn a profit.
This is a complicated and risky strategy that has the potential to make big gains or result in significant losses.
Leverage In Real Estate
As already discussed, one way to leverage real estate is to take out a mortgage on a property and then rent it out. If you put 20% of your own money towards the down payment, the other 80% of the purchase is leveraged. This allows you to purchase a property worth more than you could finance on your own.
The rental income can provide regular cash flow and the potential to profit from the sale of the property if it appreciates.
Another way to leverage real estate is to use a mortgage to purchase a property that you then fix up and try to sell for a profit.
What’s The Difference Between “Good” and “Bad” Debt?
When you hear the word “debt” you might immediately think of the bad version of debt such as credit card debt or high-interest payday loan debt.
However, when used in the right way, debt can also be good. While bad debt can have a negative effect on your finances, good debt can help you improve your situation.
What Is Bad Debt?
When you borrow money to buy something that decreases in value, that is considered as bad debt. For example, using a high-interest credit card to go on vacation when you know you can’t afford to pay your bill in full is an example of bad debt.
Bad debt often creates stress and can have a negative impact on your credit score if you can’t repay it. Bad debt may also make it harder to achieve your financial goals.
What Is Good Debt?
Good debt is when you owe money for things that can help you build wealth over time, and improve your financial future.
Mortgage debt is often considered good debt because it helps you build equity and avoid spending money on rent. If your home increases in value, you can eventually sell it for more than you paid.
Student loans are also seen as a form of good debt because you’re borrowing money to invest in yourself. The hope is that by taking on debt to get an education this will help you secure a higher income in the future.
Will You Use Debt to Make Money?
While it’s generally good advice to avoid debt such as high-interest credit cards and loans, good debt exists. By using strategies such as short selling and leveraging, there’s potential to generate income and improve your financial future. However, it’s important to weigh the benefits and risks. Before you take on any type of debt, take some time to do your research. Understand how much it will cost to borrow, review the pros and cons of the strategy you intend to use, and have a solid plan in place for how you’ll repay the debt.
