Did you know that debt is a powerful tool to build wealth in certain cases? The largest corporations in the world often use debt that they leverage for expansion and growth. It is regularly discussed as a tool for community and social development and in global financial stability reports.
Wealthy individuals understand how to take on healthy debt to get bigger financial returns. Want to learn how to leverage debt to secure your financial future? Read on!
What qualifies as debt?
Debt is anything a person borrows but usually refers to money to be paid back later. Debt can come in the form of mortgages, loans, credit card debt, lines of credit, overdraft fees, and any other outstanding balance to be paid back. In most cases, the borrower will pay back the loan with interest as a condition of extending a loan or credit. Below are four common categories of debt.
- Secured debt: Secured debt is backed by something holding value, called collateral. Examples of collateral are homes, cars, savings accounts, and investments. The borrower agrees to pay off the debt or risks losing whatever they put up as collateral.
- Unsecured debt: This is an uncollateralized debt. Student loans are an example of unsecured debt.
- Revolving debt: With revolving debt, borrowers get a line of credit, and when borrowers pay back the amount that they have drawn from the line of credit, the line of credit line replenishes. Credit cards are one of the most common forms of revolving debt and require monthly repayment.
- Mortgages: Technically a form of secured debt, mortgages are significant enough to be classified separately. A mortgage will be the most significant debt for most people, and the home is its own collateral.
Advantages and disadvantages of debt
People often view debt negatively and for good reason. Poor choices can create a cycle of debt with credit cards and loans. But debt can also help you get ahead.
The pros of leveraging debt are the additional financial opportunities it can open. You can take on a loan to accomplish goals that will produce more money in the long run. The cons involve taking on too much debt and getting caught in a cycle of debt.
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Here’s how debt can help you get ahead: When you get a mortgage to buy a house, you’re taking on debt. But the house’s value may appreciate over time, and you can pass this value on to your children, leading to generational wealth. Taking on a business loan to start a small business is another example of leveraging debt.
How do you leverage debt wisely? It’s important to weigh the risks and consider your options to use debt to your advantage.
How does asset leverage work?
To leverage means to borrow capital with the expectation that the financial gains will be greater than the amount borrowed. You use a certain amount of money like a lever to generate greater wealth.
Generally, leveraging debt is done to pay for something that becomes an asset or generates income. Leveraging debt involves weighing the financial risk and the potential for rewards to decide whether it is a good fit for your situation. Examples of ways to leverage debt:
- A mortgage to buy a house
- Taking a personal loan to pay off high-interest debt
- A loan for a small business
- A loan for the expansion of a business
- Understanding leveraged investments that use leveraged debt, such as leveraged exchange-traded funds (ETFs)
When you take out a personal loan to pay for anything like wedding expenses or car repairs, you’re not really leveraging debt. But taking a low-interest loan instead of putting the expense on a high-interest credit card is a form of leveraging that will save interest payments in the long term.
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7 tips on how to leverage debt and improve financial opportunities
Here are the steps to use debt to your advantage to build wealth.
1. Build your credit
Building a good credit score could open better loan terms and opportunities to leverage debt. If your credit score isn’t already above 740, consider a credit-builder loan to help improve your credit score. A credit-builder loan is an example of how debt can actually help you financially by building a credit history and a good credit score.
You can also try rent reporting companies or becoming an authorized user to build a credit history faster.
MoneyLion can help! Credit Builder Plus (CB+) is our powerful credit-building membership, and it’s designed to help our members build or repair their credit, save, establish financial literacy and track their financial health. CB+ membership can help you build or improve your credit with access to a Credit Builder Plus loan. A Credit Builder Plus loan is a small loan that is held in a secure account while you make monthly payments. As you make payments, they are reported to the major credit bureaus, which can help boost your credit score with on time payments. Plus, you get access to some of the loan funds as soon as they are approved, so you can use them for whatever you need. CB+ is a smart way to help improve your credit while paying off your debt. By improving your credit score, you can qualify for lower interest rates on future loans or refinancing options. And by paying off your Credit Builder Plus loan on time, you can reduce your debt-to-income ratio, which could also improve your credit score.
2. Aim for low interest rates
Once you’ve built your credit score, it’s time to negotiate with creditors and find ways to lower interest rates on existing debt. This could save you hundreds of dollars per year in interest. If creditors don’t give you a lower rate, consider applying for a personal loan with a lower interest rate or a debt consolidation loan.
3. Invest in your education
When used wisely, student loans can increase your earning potential. Be sure to choose the field you are going into carefully to increase the chances for a return on your investment. Don’t be afraid to explore trade schools and practical skills-building programs to launch your career for less and potentially get a better return on investment.
4. Take on a home mortgage
Taking on a home mortgage can help you turn debt into an asset over time. When you pay monthly rent, that money is gone forever. When you pay down a mortgage, you buy a portion of an asset (your home) each month.
Getting a mortgage can set you up for a secure retirement and help you “earn” money as the value of the home increases throughout your lifetime. It will also make your money work for you, rather than giving it to someone else through rental income. This type of debt can be beneficial for your security and as a powerful tool to pass on generational wealth.
5. Invest in high-yield assets
Investing in high-yield assets like real estate investment properties is a powerful way to leverage debt. To do this successfully, you must research the market and learn from experts to understand how to choose an investment property.
Some will also borrow to invest in stocks or leverage investments.
6. Start or grow a business
Taking on debt to start a business is risky, but it can be worthwhile if your venture succeeds. You should research the market, create projections, understand the break-even point, and consider the experts who will join the business. With a clear business plan, taking on debt for business can be a smart move, but without a clear plan, it’s a liability.
If you’re already in business, leveraging debt to expand can take your company to the next level. Whether that’s a second location, a new product line, or expanded personnel, using debt to grow your business is often necessary. As always, research and consult with experts so the business reality matches expectations,
7. Take advantage of tax deductions
Some interest payments on debt are tax-deductible if you count them as a business expense. This can reduce your net tax obligation. Speak with an accountant to understand whether your interest payments qualify for tax deductions.
How To Leverage Debt For Your Goals
Remember that leveraged debt is not just a loan. It’s a lever (or catapult!) to help you build more wealth. A home mortgage, real estate investment properties, low-interest loans, and business loans can all be smart ways to leverage debt.
Whether they fit with your current income and financial goals is unique. In addition to researching and fact-checking any possible investment opportunity from home to business expansion, you’ll need to consider your total debt, income, and expenses before taking on any debt.
Keep leveraged debt in your financial strategy playbook. Whether now or in the future, you can use debt to build wealth.
FAQ
Is leveraging debt a good idea?
Leveraging debt can be a good idea, but it depends on how you do it. Leveraging debt can open new financial opportunities if you use it to build wealth with a clearly defined, well-researched plan. Don’t just take on credit card debt.
Can leveraging debt help your credit score?
While it’s not generally recommended for credit building, leveraging debt can help your credit score in some cases. For example, a credit-builder loan is a debt designed to build your credit score. Diversifying your credit mix also may help improve your credit score.
How does leverage affect debt?
When you leverage debt, you’ll be responsible for paying back the principal plus interest. If you leverage debt successfully, you’ll make more than the repayment amount by leveraging the money to work for you.
