Leverage: Is Debt Good or Bad; How can you use Debt to Make you Money?( Part2)

How can you start using debt?

Credit cards: Some people fear credit cards and view them as a means of the government or banks to begin tying you in debt, but that need not be the case. The golden rule here is to spend money that you were already going to spend, and with money you already have. For example, if you saved up to buy the latest iPhone, you can pay for the phone with your credit card and at the end of the month, pay off the debt from your savings account. The wrong thing to do would be to buy the latest iPhone or go shopping for cool shoes and clothes that you know you do not have the money for and allow the debt to pile up. This is what would have debt pulling you down.

 

To make the most out of debt, you need to have a good credit score, and the first and easiest place to start from as a beginner is owning a credit card. To get a good credit score, you need to have a credit history. Not holding any form of debt is just as bad as being bad with debt. If you do not have a history with debt, there is no way for a lender to know how good you would be with debt so avoiding all form of debt will not be the best way to go. The better option would be to manage this debt and manage your excesses.

NB: A credit score is simply a number that tells a lender how good of a borrower you are and how likely you are to repay debt. There is a pretty elaborate way for calculating credit scores if you want me to explain how it is calculated in a later article, I would be happy to do that. There are other benefits you could get from using credit cards such as points for travel, discounts, cashback, getting your money back if a purchase goes bad and the business is unwilling to refund, or if your money is stolen and so on.

Real estate investment: This is where your credit score comes into play. When you want to buy your first house or apartment, you do not have to save or invest all the money you need to do this as was described in this article The term "mortgage", which is just a fancy term for a loan to buy property, comes into play here. Can your home be an investment? Yes, it could be but more on this in the next article on this newsletter. You can subscribe so you can be notified as soon as that article is posted.

With interest rates at close to zero, the term "refinancing mortgages" seems to be flying around a lot, what does that mean?

Refinancing a mortgage is simply getting a new mortgage (loan) to pay off an old loan. On the surface, you might think wait; this does not make sense, why would you borrow to pay off something you already owe? Doesn't this go against common financial sense? Well, not always. There are some benefits to refinancing loans. When interest rates are lower, getting a new loan could mean that you could now have a lower interest to pay. For example, if you locked in a 30-year fixed-rate mortgage at 5% interest in 2015 but now that rates have fallen, you see that you could get a loan for 2.5% interest, you might want to consider getting a refinance because of the reduced interest payment you can get. Also, when you get a mortgage, the monthly interest payments you make help you build "equity" or ownership in the home. So, the more monthly payments you make, the more you own the home. As such, you could do what is called a "cash out refinance" which allows you to get some of that money out of the loan and you could spend or invest that money in another property or in buying stocks or whatever you would like. As time passes or as you undergo renovations on your property, real estate values tend to go up. If you have your house revalued by an appraiser and your house is now worth more money, you can have a cash out refinance to get some money out of the property.

Business loans: If you look at the financial statements of publicly listed companies, you might see some common line items like "long term debt" "short term debt" "interest payable" etc. With interest rates at close to zero, debt can be a good way to get access to cheap capital to expand business operations. Remember the explanation in this article as time passes, and inflation rises, the loan becomes cheaper to pay off as the value of money the business pays is lower.

Debt can be used for other things such as buying a car, student loans etc. The logic behind debt is simple: will this debt (in the short or long term) directly or indirectly make more money than what the value of the debt plus interest costs? If yes, then it is good debt. If no, then it might be bad debt.

Final thoughts

Debt is not static. What does this mean? Good debt can go bad and bad debt can turn out to be something good. There are several examples of how big businesses or businesspersons take large loans and are unable to pay because their business does not go as well as planned. There have also been instances where seemingly frivolous purchases have yielded great financial return. As I said at the beginning of this article, debt on its own is neither good nor bad; it is what it is used for that makes it so. This means you could also say, debt is neither good nor bad; it is what it yields that make it so. If the outcome of the debt is more profitable than the debt and the cost of repayment, then it could be said to be good debt, and if the outcome of the debt is bad, it could be said to be bad debt.

There are also risks associated with debt. When you borrow money, you have the continued fixed cost of that interest. Irrespective of how business goes, you have to pay that interest. If your business experiences is a short-term downturn, you could go into bankruptcy because you can no longer pay your interest. Are those borrowed resources being used efficiently to generate enough profit to be able to pay the interest on the borrowed money? If not so, you're digging yourself deeper and deeper into a financial hole. As there are benefits to debt; there are also risks to debt.

You do not have to see debt as a burden to be carried around in a box.

If managed properly and used for the right reasons, debt can make you more money. Does this mean you should go out borrowing to invest in every good opportunity you see? No. Like almost every other thing, debt must be taken in moderation. As too much debt can be harmful and put you at higher risk of bankruptcy. Debt is not inherently good or bad, you must not run from it, but you also must not drown in it; you just need to be prudent in how you incur debt to make the most out of it.

Source: @(Oghenerukevwe Odjugo | LinkedIn