How to Use Debt to Build Wealth

Debt is often associated with financial burden, but careful and strategic debt use can be a powerful wealth-building tool. There are several different ways to use debt to grow your wealth, but you’ll want to be aware of the risks associated with each one.

In this article, we’ll look at some potential ways to use good debt as a tool to grow your capital and steps to create a wealth-building strategy that works for you.

Debt used to purchase assets that can grow in value is considered good debt.¹ Mortgages, student loans, and in some cases, business loans are examples of good debt because they can produce an investment return or gain.

On the other hand, bad debt is debt that may deplete your finances and, in some cases, even damage your credit. High-interest debt is typically considered bad debt, especially if the debt is used for something that offers no chance of an investment gain. Bad debt creates a financial strain, it isn’t a wealth-building opportunity.

Learning how to use debt to build wealth can change how you view finance. There are several ways to leverage debt effectively, including low-interest financing for investment opportunities and utilizing leverage in real estate transactions. As with any investment, though, these investments are not without risks. Be sure to carefully consider the potential risks before investing in them.

With this in mind, let’s take a look at three examples of how debt can be used to grow your wealth:

• Mortgages
  Taking out a mortgage to buy a property can be classified as good debt. A mortgage can allow you to gain access to housing, and if you purchase in the right location, where property values are increasing, then your home may even appreciate in value over time, allowing you to potentially sell it for more than you paid. A mortgage on an investment property is also considered good debt, as you could be able to use the rental income (in addition to potential appreciation) to invest.
  
  Note that the exact return on investment (ROI) you’ll get for a rental will vary, depending on factors including location, the type of property you buy, and the financing you’re able to secure. It may be advisable to target a return of between 8% to 12% if you buy a residential rental property.² As a comparison, the average annual stock market return for the past twenty years was 6.96% (with dividends) when adjusted for inflation.³
  
  
• Business Loans
  Taking out a loan to infuse cash into your business may or may not classify as good debt. It’s how you use the money that matters. Investing in the marketing of a new product line could result in increased sales and higher profits. Using that same cash to throw a party for your employees might help boost company morale, but it won’t necessarily bring in new revenue.
  
  The risk with business loans is that your company needs to pay them back. That’s easier to do if you invest the money into marketing or growth projects. Evaluate that carefully before you take out a business loan. While you’re at it, you’ll want to consider a business line of credit. They’re a more flexible way to finance a project or product launch if you don’t need all the money upfront.
  
  
• Student Loans
  Borrowing money for student loans can be another form of good debt. Student loans allow you to invest in your future, helping you to gain the skills that you need in order to obtain a certain job.
  
  Before taking out student loans, it’s a good idea to carefully consider how much your future job is likely to pay once you graduate, and calculate how many years it will take you to pay the loans back.

It’s important to note that there’s a big difference between investing with debt and investing in debt. Investing with debt involves using debt to increase your wealth. Investing in debt, on the other hand, refers to debt investments.

Examples of debt investments include fixed-income products like bank loans and bonds.⁴ Cash-strapped companies often prefer using these debt instruments instead of issuing and selling new shares of stock that will dilute the value of the existing shares. Investing in debt could help you diversify and stabilize your portfolio, and these instruments are considered suitable for low-risk investors.