With the appropriate use, debt can be an incredibly useful financial tool; the problem is that the vast majority of the population doesn’t understand how to use it properly. Instead, they see debt as a way to simply buy things they can’t afford and doom themselves to paying an average $600,000 in interest over the course of their life.
Like any tool, debt requires vast knowledge and expertise to use effectively. Otherwise, you’ll easily smash your nest egg or drill holes into your carefully crafted lifestyle.
Before you can even consider taking it on for the purposes of building wealth, you must first understand a few commonly overlooked truths about debt.
Debt is designed to make lenders rich
Let’s get one thing out of the way: banks are not charities. As you may know, when you take out a loan, you get charged interest on the money that you borrowed. This interest ensures that your lenders see a return on the investment that they made when they loaned you money.
Long ago, lenders realized that people wanted to be lent money so they could buy things they couldn’t afford, and the lenders found a way to profit off of this through interest payments. And that is how banks were born. (A bank isn’t just a place to store your money. That feature actually came much later.)
Until you realize that lenders aren’t your friends and your consumer debt is making you poor, you’ll never be able to utilize debt in an effective, wealth-building way.
Debt crushes those who can’t live without it
Take a look at the common American household’s spending, and you’ll see a disturbing trend. For most people, debt is an ongoing cycle throughout their entire lives. They’ll finance a new car, buy a new house, make payments every month, trade in the car when it’s not cool anymore, sell house when it’s not big enough, make payments every month, and repeat until death. Most people never learn to live debt free.
These aren’t the people who retire at 30. These aren’t the people who abandon the 9-to-5 and travel the world. There is no life beyond debt for these people, and they continually doom themselves to endless interest payments.
If a person ever hopes to find out what “debt as a tool” really means, they need to be looking at it from the other side of the fence: you can never see debt for what it really is, both the good and the bad, without first learning to live without it. If you insist on continuing the cycle of endless debt, then building wealth may never be within your grasp.
Debt is a tool when you can minimize its impact
There’s one key component in making debt useful for your financial path: leverage. If you ever hope to build wealth in a venture that requires debt, you won’t get anywhere without something of value that can be leveraged in order to generate returns that outweigh the debt.
Let’s take houses for example. Since houses are often cited as being a good investment, let’s first ask how the house is being used: are you taking on a 30 year mortgage in order to live in a fancy house? In this case, what you’re leveraging (and what you could lose) isn’t just a house; it’s your home—where you live, raise your family, and make memories. Is that something you really want to leverage in a transaction that makes up one of the biggest purchases you’ll make in your life? Because of this, it’s perhaps best to purchase a house that’s within (or even below) your means. This increases your chances of paying off the house quickly and with minimal impact to your finances.
However, consider someone who buys a house as a rental property. Though they might take on a mortgage to pay for this house, what they’re leveraging is an empty house that also happens to be a valuable asset. Through proper property management, they’re able to make an investment that could see a high return. More importantly, there’s minimal impact from the debt used to purchase the house since the renters are the ones making the monthly mortgage payments.
To recap, debt is only a tool when it’s being used to generate revenue, which can then be used to pay back the debt along with provide you an income steam. Otherwise, debt is not a tool. It’s a handicap.