America is addicted to debt. There’s $12.29 trillion in household debt just through till the second quarter of 2016. I can’t imagine what the amount is now. It’s not just the consumers who are in debt, the government is too, with an estimated $19 trillion in debt by the end of FY 2016. The government’s Federal Tax revenue is an estimated $3.3T. An almost 6x income to debt ratio is not sustainable and who knows what will happen when a recession happens. The government is living on the edge of a cliff and it only takes a small blow of wind that will push it over and wipe out everything.
I personally hate debt. I have $5,500 in subsidized student loans (I’m keeping this until December because I’m not paying any interest on it until my grace period is up, which is this upcoming December. The debt will be entirely paid off and I did not use leverage to finance my car. However, there’s an upside. I believe that debt can be a great way to propel yourself up, if used properly.
Leveraging Leverage to Your Advantage
Not every debt is evil. Mortgages, car, and student loans are fantastic ways to propel yourself forward in your personal finance pursuits. I’m a big fan of allocating resources, whether it’s time, money, or energy, to the highest value adding activities. A house gives you comfort and safety.
A car provides transportation. There’s a huge value in having transportation in that you can get to work to produce income. It also helps with saving money and optimization by being able to make weekly trips to the grocery store instead of going to the nearest convenience store and paying a premium for convenience.
Student loans give you the power and credentials to give yourself a better salary and optionality than if you hadn’t gone to college. Going to college can be a better choice than working after high school as the world is becoming more advanced and high tech. The networking opportunities that college provides don’t hurt, either.
The wage differential between a non-college holding person than a college holding person is widening. Just by going to college and paying attention in classes to get good grades provides more opportunities than someone who hasn’t done so. It’s when you’re given a chance to prove your work ethic.
These debt allow you to propel yourself forward than if you hadn’t taken them. I would call them almost necessary. The problem comes knocking in the door with the well alluded Bruno with a baseball bat when unnecessary debt is taken in.
The problem comes when you add unnecessary debt to your arsenal. Money are soldiers that can work hard for you to keep your kingdom afloat and alive. If misdirected, the soldiers are not shy about bringing back the troy horse that will lead to your downfall. Once bad debt breaks out from the horse, you’re going to be fighting an uphill battle.
Total household debt equaled $12.29T, which isn’t a bad number if it’s taken on to buy high value generating activities or products. It becomes bad when the one of the highest increases came from credit cards. Credit card debt increased by $17B dollars. That’s a lot of dollar bills, given that a million dollars is a lot of $’s already!
I personally LOVE credit cards. I can’t believe that I can take almost 2 months to pay off something that I bought. For example, if my statement ends on the 15th of August and I buy something on the 16th, then I don’t have to pay it off until October 14th. This significantly helps my cash flow numbers. It’s powerful to have the ability to pay it off later.
However, credit cards are ONLY awesome if paid off in full every month. For me, it’s set on Autopay so that I never forget to pay off my credit cards in full. I paid $0 in interest ever since opening my first account 2.5 years ago. I have 5 credit cards with different rewards categories totaling a $30,000 credit limit. It’s scary to think that I have the power to spend $30k in one month, which is why I practice discipline.
Only Use It When It Generates Value
Debt is an excellent tool to catapult your personal finance to where you want it to be. Having transportation, extra education, or a house can allow you to earn more money and cut expenses depending on how it’s used. Not every debt is a solder inside a troy horse waiting to burn your kingdom down that you worked so hard to create. It can be a blessing in disguise IF used correctly.
The next time that I make a big purchase will be when I buy a house. Since a house is an appreciating asset, I can’t follow my rule for making a big purchase (which I recommend everyone to do for depreciating assets). However, I will practice smart buying strategies and after doing a lot of research, will take on a mortgage to purchase the house. I’m following a couple of turnkey property blogs currently and looking to educate myself in real estate. One blog that I recommend is Cash Flow Diaries.
A house is a great product to take on debt for because I can produce income from it by renting it out. Transportation gets you to work which gives you income. Student loans give you income because of the higher earning potential. If you are taking on leverage to produce more indirect or direct income WITHOUT RISK, then it’s smart debt to take on. If the debt produces more income for the creditor than you, it’s unnecessary.
Don’t Lever Up Too Much
Taking on debt to buy a car, house, or an education is a good bet because the value is realized WITHOUT risk. A car gives you transportation, a house gives you a space to sleep, and an education gives you thinking skills. You realize the value of the product without any risk. Those attributes are what makes it worth taking on debt.
When risk is involved, do NOT use leverage for huge purchases (such as a rental property) unless 1) You know what you’re doing and 2) risk is mitigated. Taking on a lot of debt can cause you to have significant financial distress. Try to avoid risks where you put everything on the line where a coin decides your future. Heads you make it big and tails you lose it all. It’s almost gambling if you take on this kind of risk.
I’m not using the cash I have right now to buy a house because I’m not educated in real estate. I want to put in as much preparation as I can before exposing myself.
Be a Subject Matter Expert
You have to be a subject matter expert in a capital intensive business. Why? Competition is out there every day looking for ways to beat you. There’s always going to be someone out there who’s looking to take your business away from you. And guess what? Competition is both ethical, legal, and encouraged.
Limit your risk as much as possible and come up with your own cash to pay for the ventures. How do you limit your risk exposure? Create side income opportunities to come up with the cash. Save everything that you possibly can to come up with the money. Waiting a few extra years to start your venture with no risk is better than starting one right now with an unbearable amount of risk.
Don’t let debt be the reason your dreams are shattered. If you took on debt and want to get out, it’s never too late. Life is a marathon and you can dig yourself out anytime you want!
Readers, what do you think about debt? Do you use debt to go forward or is it setting you back? Let me know in the comments below!
My goal is to enable your success in personal finance so that you can realize the American dream. The first step is starting today!
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