What is Debt?
When you hear the word debt, you probably think of it in a negative way. Maybe you’ve heard of people “going into debt” and facing serious consequences.
The truth is, debt isn’t always bad. It is a Double Edged Sword that is also the key to wealth building.
“Debt” is simply when one party borrows something from another, typically money. Many businesses and wealthy people use debt to pay for asset and investment purchases that they wouldn’t be able to afford with just the cash in their bank account.
A debt a
greement allows them to borrow the money and pay it back later, usually with an added fee called “interest”. Having debt does mean you owe someone money, but this is not always a bad thing. When debt is going towards a smart investment that will pay off later, like a business or an investment property, it can actually serve you rather than harm you.
Behind savings, debt is the next big key to wealth that the rich and wealthy use. They use it as a very powerful tool to help them grow their assets, without it their wealth growth would be much slower.
Good Debt vs. Bad Debt
Good debt means using it towards an asset or investment that will add value or bring you money in the short or long-term.
For example, investment property loans are good debt as you will earn rent back and the asset will most likely go up in value at the same time. So if you borrow $100,000 to buy a $120,000 property investment that gives you $1000 a month back in rental income, Then that’s using good debt and the way the rich use leverage. Instead of having to save $100,000 yourself you only need to save $20,000.
Here are a few examples of good debt:
Investment loans for real estate ( Mortgages)
Small Business Loans
Investment loans for investments that go up in value or give you a return.
Student loans can also be good debt for the right courses that will get you into a good career or give you skills that will far outweigh the cost of the education.
You also need to take on and start to use debt to build a credit history, which you’ll need to get a loan for good debt.
Bad Debt
On
the other hand, bad debt takes away from your net worth or just takes money out of your pocket with no chance of a good return. These are usually frivolous purchases you want, but can’t really afford and they start to lose their value straight away.
Here are some of the main examples of bad debt:
Credit Card Debt - it’s ok to make purchases on your credit card, as long as you can pay them off each month. Never use a credit card to purchase “fun” things you can’t actually afford as credit card interest is one of the highest interest rates you can pay.
Car Loan - cars lose value so quickly so you need to make smart decisions about whether you really need one.
Personal Loans - these have a high interest rate and are usually taken out either to cover purchases people can’t afford or to pay off other bad debts. Most time personal loans are for consumables that go instantly like a fancy meal, festival ticket, clothes or a holiday. It’s gone in an instant but the debt repayment lasts a long time after that!
A good Rule of Thumb: Before taking on debt, consider whether the purchase is a smart investment that will pay for itself in the long-run. You should also research options for different types of loans and their interest rates to get the best deal.
LEVERAGE: The secret weapon of the rich
So how do the wealthy use debt to their advantage?
Good Debt” or leverage is one of the main “Key building Blocks” to wealth. Leverage here means when you use Good Debt or to borrow money to buy something that goes up in value.
For example when you take out a loan from a bank to buy an investment property that goes up in value.
One common example of the rich using leverage to build wealth is using debt to fund real-estate investing. As we mentioned before, a mortgage or real estate debt is an example of good debt when used to purchase investment grade real estate. This is because good real estate almost always increases in value in the long-term and the value of the real estate investment will usually end up being worth far more than the original purchase price and interest added together.
The wealthy know this trick very early on and spend their whole lives trying to build up a good credit rating and to find out a way to get into investments by using debt and leverage to their advantage. They may use the saving method to get started and save a portion of the investment and then you use Good debt or Leverage to get into bigger investments.
The rich use leverage in more ways than just using it to leverage debt.
Leverage is where you use any resources, such as money, time and people to enhance and increase the reach and speed of what you do. The wealthy use it as a special superpower that they know how to twist to their advantage to become richer and richer while doing less and less.
We have just shown you how they use it with debt but the wealthy also use it with people. Instead of trying to do everything themselves, they hire and use the skills of others to jump ahead in the wealth game. They use the power of leverage with people and time to get to their wealth goals quickly and they use leverage wherever they can get it as it powers them ahead.
How do you use good debt to become richer?
The first thing you need to do to get good debt is a good credit score. Building credit is like building a reputation with lenders. By being responsible with your credit, you will build a higher credit score, which will tell lenders that you are trustworthy. This makes it easier to rent an apartment, buy a car, and get a mortgage (among other big financial decisions).
Your credit score consists of a few factors. They are:
How much you owe to the bank or other lenders. You want to owe relatively little compared to your available credit and pay off your card completely each month. Say you have $6,000 available on your credit card you don’t want to always be owing a $6,000 balance on it and maxing it out every month.
How long you’ve had your oldest credit card Keeping your oldest credit card open helps your credit score
Your credit mix Having a more diverse credit portfolio with different types of loans improves your score
New credit Opening multiple lines of credit in a short period of time is a red flag to lenders as it looks like you are in financial trouble and need a loan quickly.
Getting and keeping a good credit score is important for your future investment goals. Lenders will be less likely to trust you with a loan if you don’t have a good track record with your credit card.
It can be hard for young adults to get credit cards, because, ironically, you need a good credit score to get a credit card. Here are a few things to try if you don’t have your first credit card yet:
Get a secured card This is a card that requires a deposit. You can start with a low maximum and work your way up.
Get a student credit card Some major banks have special credit cards just for college students
Ask to be added as an authorized user If you’re under 18 you can’t get your own credit card just yet. Ask your parents if you can be added as an authorized user to their credit card to help build your credit. You’ll need to check your bank’s rules, because this doesn’t always help with your credit score, but it can be a great way to start building good credit.
CreditKarma also gives some great suggestions for first-time credit card applicants. Whether or not you qualify for a credit card yet, understanding how they work and how to build good credit is the first step to being a successful future investor.
Loan Requirements
Different types of loans have different requirements, but generally you may need:
Personal information Name, address, social security number, etc.
A statement of purpose for the loan For some types of loans (like business loans) the lender may want to make sure you have a clear vision of exactly how you’ll use and grow their investment
It’s best if you are wanting to get an investment loan for your first property to speak to a Mortgage broker who will talk you through the requirements and also they will know which banks will be best suited for the type of loan you need. Each bank’s lending policies are continually changing and a good mortgage broker will know the lending landscape the best. Typically finding one that can be personally recommended to you is the best by someone who has used them recently.
Debt is an Accelerator and double edge sword
So you can see that Debt is really an accelerator. If used wrongly it can make you poor very quickly and if used in the correct way it can accelerate you to wealth.
The rich and wealthy have known this secret for a long time and have used this tool to make them wealthy. It’s one of the main reasons why the rich get richer! Make sure that you know how to do the same for yourself too.
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