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You probably have first-hand experience with debt. By the time we hit 21, most of us have student loans, an auto loan, and maybe some credit card debt. So you’re familiar. You already know debt is simply borrowing money and paying it back with interest. And you know interest is really just the cost of borrowing the money.
There are a couple different ways of thinking about debt:
1) Debt is evil and will destroy your life. Save until you have enough cash to buy what you need, and pay cash for everything.
Or 2) Debt is a totally normal part of life now. We should all enter adulthood knowing we’ll always have a car loan, student loans, and a credit card bills until we die.
I’m hoping you fall somewhere in the middle of those two statements 🙂 Most people understand debt as more of a necessary evil. You don’t want it, but you feel you need it to create an acceptable lifestyle. That’s probably mostly true.
But what if I told you some debt can be smart. Like, it would be wise of you to go into some debt. That some debt is actually good! It’s true! Smart debt can grow your wealth and improve your life without bogging you down.
Yup, smart debt is a thing. And we can show you how to use it to build wealth and improve your life!
How is Smart Debt Different?
We all know the feeling of bad debt. That stressful, pressing, suffocating feeling. Smart debt doesn’t feel that way. It feels strategic, helpful, and perfectly manageable.
Smart debt is basically any debt that leaves you in a better financial position than you would have been if you hadn’t accepted the debt. Let’s say someone offers to lend you $100,000 at 3.5% interest. You accept that debt, then invest that money in index funds with guaranteed 7% interest. This would be smart debt because the 7% income from your investment more-than-covers the 3.5% cost of your debt. Of course, there are no guarantees, and this is just to illustrate a point. Please for the love of all that’s good and holy, do NOT accept a loan to play in the stock market!
So how can you use smart debt to your advantage then? Well, lucky you, today we’re going to look at four different ways to use smart debt to build wealth and improve your life!
#1: Build Good Credit
Starting out in the adult world is tricky, well for a billion different reasons, but one specific reason is because you don’t have a credit history. You probably need a cosigner for your apartment lease, your cell phone plan, your car loan, because you don’t have the credit score to prove you can be trusted to make your payments on time. Smart debt is a great way to build good credit.
Here’s how: get a 0% APR credit card. 0% APR basically means 0% interest. That means you can go into debt (just a little, mind you!) without paying any interest. So this is the only time you’ll ever hear us say “don’t pay off your full balance at the end of the month”. The credit-keepers want to see you carry debt for multiple months and pay on time. So only pay your minimum payment for a few months.
Warning: the 0% APR is usually just an introductory offer, maybe for the first year or two, so make sure your balance is paid in full before the introductory period expires. And no late payments! If you pay late, suddenly your 0% APR becomes something like 18%, and applies to the total balance on your card.
I used this trick to buy my first computer. Best Buy had a 2-year 0% APR store credit card. I used it to buy the computer for $2,200. Then, to make sure I paid off the balance before the two-year introductory period expired, I divided the $2,200 by 23 months (one month buffer!) to calculate my monthly payment. I paid $96/month without fail and built a cute little credit history for myself.
Smart debt in action!
PS: Check out our post on building perfect credit from scratch if you’re lacking on the credit history front.
#2: Get an Education
Education costs have gone OOC! It now averages $20,090 per year for a tuition + room and board at a state university if you’re paying in-state prices, $35,370 for a state university if you’re paying out-of-state prices, and $45,370 again that’s per year for private universities (source). And these are just averages! Many schools cost more. Gah, I have that suffocating feeling just thinking about this.
It gets worse. You’re not just paying back the loan amount. You have to pay it back with interest.
Even though student loan interest rates are currently low, like under 4% for undergrad degrees, that interest adds up. Quick math: you take out a 15-year loan for $80,360 (4 years of school at $20,090 per year) at 4% interest. Your monthly payment will be $594.41, and that $80,360 loan will actually cost you $106,994 once you’ve paid all the interest.
But here’s the thing: your ability to earn money, and presumably your lifestyle, improve with a college degree. By a lot. CNN reports you’re about 50% less likely to be unemployed with a Bachelor’s Degree, compared to having only a high school diploma. And you make about $28,500 per year more on average than those with diplomas. So theoretically, your investment could pay for itself in under 4 years of working full-time.
That’s why student loans can be considered smart debt. The investment in your education usually pays off financially. And many people are happier with their college-degree-required career than with the high-school-diploma-only options.
Keep in mind, these cost/pay-off numbers are across-the-board averages. They include High School Grad Under-Water Welders with no student loan debt making $55,000/year as well as Unemployed Gender Studies Grads with student loans of $200,000 and $0 income. So we’re certainly not saying college is always the answer. Seriously, not everyone has to go to college. There are plenty of people happily making a good living without a degree. I love education, but education and university lecture halls are not the same thing!
[bctt tweet=”I love education, but education and university lecture halls are not the same thing!” username=”savings_sangria”]PS: If you go the college route, save yourself a crap ton of money by going to your local community college for your gen-eds. So few people take advantage of their local CC’s, and nearly every person we’ve talked to about this wishes they had. I got my MBA without any student loan debt (my husband had enough for both of us!), and community college is a huge reason why.
#3: Invest in Real Estate
Yeah, I’ll admit it, I love real estate! I’ve been in some field of real estate or other since I was 18, and J and I even have our own little real estate portfolio (ok, it’s only two properties, but SoCal is expensive!).
Here’s why real estate investing rocks my socks:
- You have a place to retire (or to sell so you can buy a new place to retire). So you don’t have to live in fear of rent increases exceeding your fixed, old-person income.
- Your net worth grows faster and higher with real estate investments.
- Rental properties make you money in four different ways! What?!
But you don’t have $400,000 in my savings account to pay cash for a house. Side note: never have $400,000 sitting in a savings account! Put that money to work by investing it.
So you need a home loan (mortgage, same thing). And home loan interest rates are still at a near-all-time low, around 4.5%. Wanna hear something crazy? When my parents bought their home around 1980, mortgage rates were something like 13%! Compared to a 4.5% interest rate, the 13% interest rate will cost you $215,824 more in the total amount due including interest on a 30-year, $100,000 loan!
You bet your tush I’m taking advantage of these low-interest rates on smart real estate investment debt!
#4: Start or Grow Your Business
Business loans are the riskiest smart debt on our list. They’re also the only item on our list that we don’t have personal experience with. If you do have experience with business loans, we’d love to get your input on the topic in the comments.
Here’s what we do know about them: There are countless millionaires who built their wealth on smart business loans.
If you’re starting a business, you probably need some seed money. If you’re looking to expand your business, that costs money too. This money can either come from a loan or from an investor buying into the company. Here’s the sucky thing about investors: once you take their money, your business owes them forever. It’s not like a loan where you just pay back your amount plus interest and you’re free. Investors usually get a percentage of the profit forever, or they want some control over your company. Depending on your company and your style, investors can be a disaster.
So a lot of owners prefer debt capital to investment capital. And as long as the investment in your business creates income that exceeds your debt+interest, you’re golden! Of course you want to be reasonably sure your investment will pay off before you accept any business debt. Projecting income based on debt capital is one of the reasons business people have all their fancy-pants financial models! So get your financial projections before taking on a business loan.
That’s our list for today! Hope you’re able to use some of these smart debts to grow your wealth and improve your life. Or maybe just feel better about your student loans 🙂
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Did we miss anything? Do you have another way to use smart debt to improve your life? Let us know in the comments!
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