Taking on new debt is not always so bad. Sometimes it makes sense to borrow money with a promise to repay the debt, particularly if you’re pursuing financial freedom.
Borrowing money can be good if you use the money in ways that allow you to build wealth. Conversely, borrowing money can be bad if it depletes your finances and traps you in debt. Below we highlight different types of debt and explain how you could use debt to make money.
Related: Does loan purpose matter?
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Can You Build Wealth With Debt?
In some cases, you can build wealth with debt. Most home buyers, for example, go into debt to purchase their home. A 2021 survey by the National Association of REALTORS found 87% of recent buyers financed their home purchase. Property values tend to appreciate over time, so homeownership can typically generate new wealth.
Students often borrow money to go to college, and most college programs provide students with an economic return on their educational investment, according to Third Way, a national think tank. Going into debt to obtain a bachelor’s degree or higher can help you build wealth over time.
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Understanding the Different Types of Debt
Understanding the different types of debt can help consumers decide whether it makes sense to borrow new money. Debt can be good or bad depending on several factors, and some of these debts can be classified as efficient or inefficient.
As mentioned earlier, borrowing money can be good if you use the money in ways that allow you to build new wealth. Taking out a home loan to purchase a house, for example, can be a good and efficient form of debt. Residential property tends to appreciate in value over time, and that’s one of the reasons why home loans are a good and efficient form of debt.
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Getting into a Debt Cycle
Bad debt, meanwhile, is when you borrow money on terms and conditions that deplete your finances. Borrowing money and struggling to make repayments is a bad form of debt that may leave you trapped in a debt cycle. Home loans tend to be good and efficient, but mortgages can be bad if you cannot afford to make monthly payments on the loan. Auto loans can be good and inefficient, because cars tend to depreciate in value but can help commuters get to work. Most U.S. workers drove alone to work prior to the COVID-19 pandemic, according to a U.S. Census Bureau report issued in April 2021.
Borrowing money to buy an appreciable asset is efficient debt, while borrowing money to buy a depreciating asset is inefficient debt. These debts can be good or bad, depending on your debt tolerance. Efficient and inefficient debts, for example, are good if they help you grow wealth and bad if you cannot afford their financial burden.
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What Is Good Debt?
Good debt is when you borrow money to meet your goals while having the capacity to afford the financial obligations. Good debt can help you buy a home. It can also help you further your education.
A good debt is manageable and can help you improve your credit score if you make regular payments on time.
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What Is Bad Debt?
Bad debt is when you borrow money that doesn’t help you realize your goals. Bad debt can deplete your finances and make it harder for you to achieve financial freedom. Borrowing money that you cannot afford is an example of bad debt.
Bad debts can be difficult to manage and may pose a negative impact on your credit score. Carrying large credit card balances across multiple billing cycles, for example, can hurt your credit score and subject you to high interest charges.
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Is a Personal Loan Debt Considered Bad Debt?
Personal loan debt is considered good if it helps you meet your goals. Conversely, personal loan debt can be bad if you cannot afford the monthly payment. Getting a personal loan can broaden your credit history and help you improve your credit score if you repay the loan in full without missing payments.
You can use personal loans to consolidate debt or pay off debt, which can be good for your wallet. Personal loan debt, however, is bad if it depletes your finances and serves no purpose to advance your goals. You may consider paying off your loan early if you carry bad personal loan debt.
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Using Debt to Make Money
Using debt to make money can be as simple as borrowing money to buy a home or other appreciable assets. Real estate investors, for example, may use hard money personal loans to engage in the practice of house flipping for a profit.
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Debt Tolerance
Debt tolerance is your ability to absorb new financial obligations. Consumers with high debt-to-income ratios may have zero tolerance for taking on new debt. As mentioned earlier, carrying bad debt can be difficult to manage and may have a negative impact on your credit score. Borrowing money doesn’t make sense if you cannot tolerate the debt.
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Removing Bad Debt
Removing bad debt can help you improve your financial outlook. As mentioned earlier, bad debt can deplete your finances and make it harder for you to achieve financial freedom. You can improve your debt-to-income ratio and credit score by removing bad debt. Such improvements can help you qualify for additional funding on better terms.
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Getting Good Debt
Getting good debt can help you build wealth. Mortgage loans, for example, can help you buy real estate, and acquiring equity in residential or investment property can bolster your net worth. Any debt that improves your financial outlook is a good debt.Here are five ways you can use personal loan debt to build wealth.
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1. Home Improvements
Personal loans can provide you with financing to make home improvements. Homeownership is a source of wealth. Using a loan with no collateral needed to improve your home can bolster its value and may allow you to sell it for a higher price.
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2. House Flipping
As mentioned earlier, investors can use hard money personal loans to buy residential property and resell it quickly for a profit. This house-flipping strategy is risky, but it may help investors build wealth if they know what they are doing.
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3. Start a Business
Personal loans can provide individuals with financing to start a business. Successful businesses can generate wealth, but aspiring entrepreneurs may not qualify for traditional business loans until running the business for at least six months. That’s where personal loans can come in handy to help aspiring borrowers pursue their dreams.
It’s important to note, however, that some personal loan lenders do not allow borrowers to use the funds for business expenses. Lenders may impose different restrictions across their consumer lending products. You can check with lenders and ask whether their personal loans have any restrictions on business use.
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4. Cash-flow Management
Using cash-flow management to monitor your income and avoid missed payments can build wealth. You could manage your cash flow in a way to pay off loan obligations early, which can move you closer to financial freedom.
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5. Debt Consolidation
One of the reasons you might apply for a personal loan is debt consolidation. Consumers with high credit card revolving balances, for example, may consolidate and replace those debts with a more affordable personal loan. This can help you build wealth by minimizing interest charges.
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The Takeaway
Going into debt is not always a bad decision. Borrowing money to advance your goals is an investment strategy that can help you grow your net worth. Having access to credit may present you with opportunities to build wealth and achieve financial freedom.
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This article originally appeared on LanternCredit.com and was syndicated by MediaFeed.org.
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