I often hear clients, friends, and the general public tell me about how they are in debt and miserable about it. This post was written for the purpose of dispelling the myth that it is bad to have debt. In fact, I hope that by the end of this article you think about how you can use debt to your advantage. The truth is: you can use other people’s money to help build your financial future.
Types and costs of debt
There are many types of debt in today’s world and they all have different borrowing costs associated with them. Based on the effective annual interest rates you need to pay a creditor, you can classify debt as either cheap or expensive. Cheap debt is an amount borrowed at a very low interest rate, and expensive debt is the opposite, money borrowed at a high interest rate. Have a look at some of the types of debt and their costs below.
|Type of Debt||Typical Cost of Debt in 2014|
|Credit Card debt||Between 15% and 20% per year effectively|
|Unsecured Line of Credit debt||Between 5% and 10%|
|Secured Line of Credit||Between 3% and 5%|
|Government and Student Loans||Between 4% and 6% (after grace period)|
|Mortgage debt||Between 2.5% and 10%|
The table should illustrate the fact that borrowing money from some sources is much more expensive than others, and that you can strategically use your borrowing credit to try to pay the least amount of interest possible. An example of this is borrowing money from a line of credit, to pay off your credit card bills. Instead of paying close to 20% interest, you could pay between 5% and 10%, which will equal huge savings over a few years.
Investing with debt
Once you have realized that debt can be borrowed at low interest rates if you have good credit, you may want to borrow money and invest it. Some readers might say that that is much too risky for them but the truth is; most people around the world borrow money and invest it, IN THEIR HOME! A mortgage is a prime example of an investment using borrowed money. Generally speaking, the value of a property should increase in value over time and a home is a capital expenditure that most of us need, making it a good investment. What if you borrowed money and invested it in the stock market? In the past year, the Dow Jones Industrial Average has increased in value by 14.6%**. If you borrowed $50,000 from the bank using an unsecured line of credit with an interest rate of 6% you would have made a nice profit. To be exact:
You would have had to pay $50,000 x 6% = $3,000 in interest, and your investment gain be worth $50,000 x 14.6% = $7300. After paying off your interest to the bank, you would be left with $7,300 – $3,000 = $4,300 in profit.
Now, I am not suggesting you max out your lines of credit and roll the dice in the stock market, but the lesson is that if you can borrow at a low cost and earn a higher rate of return in an investment, you can make your debt work for you.
Stay tuned for more finance!
**On March 7th 2013, the Dow Jones Industrial Average closed at a price of $14,329. On March 6th 2014, the average closed at $16,421, an increase of 14.6%.