Learn how the rich use debt differently
NOVEMBER 4, 2017 AUTHOR: SHAUN
Debt shouldn’t scare you – not all of it is bad. But both good and bad debt exist, and you should know the difference!
People have various perceptions of debt. Some have had bad experiences with it, avoid it at all costs, and teach others that it’s a terrible thing. On the other side of the spectrum, you have debt-hungry people who can’t quite get enough (for both good and bad reasons!).
Now let me be clear – I’m not one to preach that everyone should take on more debt. In fact, I think some people use debt for the wrong reasons, living for today rather than saving for tomorrow.
Just as importantly, though, I find it critical to paint a full picture of what debt is and how to use it to your advantage.
Related post: How not to overspend and save money
Good debt vs. Bad debt
Not all debt is bad. For example, without debt, most of us would never own a house or maybe even go to school. There may also be times in life you need to borrow for an emergency.
But what are some guidelines you can apply to decipher between what debts are good or bad?
Good debt can help you earn more in the future. For example, a student loan can help fund education, which can place you in a higher-earning career.
Bad debt, on the other hand, costs you more. Borrowing for vacations, cars or toys (often at high rates) only cost you money. They have no direct impact on your earning potential.
There is also a threshold where good debt loses its value. If you’re not careful and take on too much debt, regardless of how “good” it may be, it starts to lose its utility. Just because you’re borrowing money for school, doesn’t mean you should rack up $100K in debt to finance it!
The rich use debt differently
Rightly or not, I’ve come to realize that people approach debt differently based on their income.
Generally speaking, the “Average Joe” uses debt to finance “liabilities” – things that only have a cost. Good examples of this are cars, electronics, and vacations. Sure, you get enjoyment from them now… but that’s it. They only cost you money, and you’re no further ahead financially by buying them.
To make matters worse, these types of purchases don’t keep their value. In fact, a lot of times, it’s quite the opposite. They lose their value at a rapid rate (cars depreciate as soon as you drive them off the lot!)
The truly wealthy however use debt differently. Instead of splurging on “things”, they put debt to work. They use debt to invest in assets that earn them money in the future.
This is a massive mindset change. The wealthy treat debt with respect. They use it selectively as a tool to buy things they can’t afford with their natural savings in order to produce even more income.
In other words, the wealthy use other people’s money to make money.
A real-life example: Real Estate
It’s not a hard concept to fathom. In fact, all homeowners benefit from a similar principle today without even knowing it.
Instead of paying $350K for a property outright, you might use $75K of your money, and $275K from the Bank to buy your house. Over time (say 10 years) your home might appreciate to $450K (a $100K gain… at only a cost of $75K to you – your down payment!).
Now whether you purchased your house outright or not, you would earn the same $100K of appreciation. You’ve benefited from debt though because it cost you a lot less – only your down payment.
The wealthy use a very similar approach, many times over, to buy investments (rental properties, stocks, even businesses). If done correctly, and with caution, a lot of money can be made over time!
Change your mindset on debt
Ultimately, debt should be respected, not feared. Debt itself doesn’t get you into trouble – poor use of it does. You need to be very diligent and know your own limits before using it.
Let’s be honest here, borrowing to invest is not for most people. It comes with a lot of risks. That being said though, just about everyone can learn from the rich in how they approach and think about debt.
This requires a mindset shift for most of us. The truly wealthy don’t rack up bad debt on things that depreciate. They don’t live beyond their means. And they certainly don’t overextend themselves with a debt burden. Instead, they focus on building assets and future money-making investments.
If you’d like to start building wealth, avoid taking on bad debt, and live for tomorrow, not just for today.
Think it through
- How have your past experiences shaped the way you looked at debt?
- How might you use debt to unlock future growth potential?
- What risks do you need to be aware of before increasing your debt?
- Should you pay down debt or invest? Part 1 – Save thousands by making the right call
- Should you pay down debt or invest? Part 2 – Find out how to start now!
- How not to overspend and save money
- The high cost of waiting to invest – why are you waiting?
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