In the financial management world, debt is always the villain. Financial gurus, TV shows, and books tell you to stay away from borrowing money. There is always that one character who’s struggling to pay off student loans. Then that business closes down because the owner cannot afford to make interest payments.
There is truth to that. That is why it is a common trope in books and movies. Paying off interest can disrupt cash flow and throw your financial standing off balance. But what if you can make borrowing money work for you? What if you don’t have to be afraid of borrowing money if you’re going to use it for a practical purpose?
In fact, there is a practice called leveraging. For investments, leveraging is when an investor borrows money to buy more stocks or execute a new investment strategy. Businesses use leverage to fund growth in business operations. As such, companies can use these funds for launching new projects or expanding operations. Even in personal finance management, people use this. Mortgage debt is an act of leveraging. Buying a car with a car loan is a form of leverage.
That said, here are three tips to help you be smart about borrowing money:
1. Know Bad Debt and Good Debt
People often say that all debts are bad. However, given the situations above, you know by now that that is not true. For some people, there is no other way to make money but by borrowing.
If you use the borrowed money to generate income and build wealth, that is good debt. You can use borrowed money to start your own business finally. Or borrow money to buy that machine that will increase your product’s production rate. Use debt so you can move your business to a more prominent place.
Investing in education is also worth borrowing money for. Good education increases your value as a workforce asset. It increases your earning potential. Invest in a degree or a training program that will help you earn more down the road.
Money spent on real estate is considered good debt, provided that it rakes your rental income. Take out a home loan and rent the house out. The rent money can go to paying off the loan amount.
Now, what is bad debt? Bad debt is when you borrow money to spend on consumables that have little to no impact on your financial growth. Do not use your credit card to purchase the latest phone model out there. If you don’t use the phone for practical reasons, do not “buy” it. A practical reason to buy the latest phone model is to help you save or earn money or if you will use it to generate income from side hustles such as freelancing.
2. Learn About Debt Recycling and Tax Deductions
Debt recycling is a tax-efficient strategy to pay off non-deductible debt. A home loan is an example of a non-deductible debt. For example, you have a home loan amounting to $200,000, and you have a lump sum worth $100,000. The lump-sum can be from your savings or inheritance.
You might want to invest your $100,000 on something, so your money will grow. This process is not how debt recycling works.
You can split your home loan into two so that you have two $100,000 loans. Pay off one of the loans using your money and then pull it back out. You can use the money you pulled back out on capital investments. This strategy will make the loan you borrowed against your house tax-deductible.
You have to learn about tax deductions and how to do debt recycling properly. This will eventually make you earn passive income while paying off your debt.
3. Take Advantage of Loans for Your Specific Needs
There are several loan programs for different needs. One of them is an SBA-backed loan. The US Small Business Administration (SBA) offers loan programs to help small-time entrepreneurs and businesses.
If you are a small-business owner, you can take advantage of this program. You do not apply directly to the SBA. The agency only facilitates the loan by matching you with potential lenders. Contrary to popular belief, these loans are not easy money. The program enforces strict rules to ensure proper transactions.
Borrowing money doesn’t have to be daunting. However, you have to have built financial discipline before taking advantage of debt. You have to make sure that you are capable of making responsible financial decisions. This way, you will reap the benefits of something most people are afraid of.