Money Match-Up: Is Debt a Money Tool or Some Form of Evil?

Money Match-Up

Here’s the latest post in the Rockstar Finance Money Match-Up series where two money bloggers argue opposite sides of an issue.

Today’s issue is certainly an interesting one — is debt a tool or something to be avoided at all costs?

We’ll start with Mike from Miked Up Blog who is in favor of using debt as a tool…

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Before you write this post off because of some past experience or personal vendetta against debt, let me challenge you to open up your mind. Just a little bit. And let’s peer over that massive wall that separates those that hate debt with the fire of 1,000 suns from those that casually use it to get ahead in life.

I know you’re wondering so I’ll answer. Yes. Educated and experienced people do willingly choose to use debt as a money tool. And if you’re not willing to consider doing the same, you’re effectively shrinking your financial arsenal.

Effectively using debt isn’t for everyone. But if you know what you’re doing and the situation is appropriate, using debt to your advantage can be one of your best moves!

…Yeah. I said it…

Debt can be good. And here are 6 great examples of when to use debt to get ahead:

Debt and Personal Finance:

1. Refinancing your mortgage or student loans

When my wife graduated from dental school 4 years ago, we found ourselves inundated with student loan debt. Sure, the total number was terrible, but almost as bad was the fact that she had over a dozen loans spread across 3 different lenders. Each sum was different as were their interest rates and repayment terms.

The 1 constant was that each interest rate was between the 5.8 – 7.9% range. Just terrible. When we decided to get control of our debt (the student loans made up only about 32%!!), we were determined to use all of the financial weapons available.

We ended up refinancing all of these loans with one lender. By wrangling all of these student loans under 1 roof, we were able to create 1 payment term (10 years), 1 monthly payment, and – probably most importantly – 1 interest rate (5.25%). Now, we are able to make the same “minimum” payment that we had been making previously to effectively reduce our repayment term (estimated 7 years) and total interest paid (by over 5-figures)!

Granted, you’re not taking on more debt in this example. But you are restructuring the current debt you have to make it work more effectively on your behalf. No matter your opinion on student loans, they are an investment in your future self, and an example of using debt to advance your financial position.

2. Investing in real estate using leverage

If you’re on the FIRE (Financial Independence / Retire Early) path, pay off debt path, or (insert any) path – after you’ve cut all unnecessary expenses there isn’t much room left for improvement. Unless you increase your income, that is. A popular way to boost that income is through investing in real estate.

I don’t know about you but I don’t have an extra $100,000 lying around to buy a duplex. So, we’re left with the alternative of financing. Some options include seller financing, finding an outside investor, or a good old-fashioned bank loan.

The idea here is that your income gained (rent) exceeds the cost of debt and maintenance on your rental unit(s). If the equation is in balance, you’ve just advanced down your respective path a few big steps further. And unless you’re independently wealthy (me either – not yet), that was done using debt as a tool. Nice work!

3. True emergency

Let’s face it – most of us want a plump emergency fund. Those of us with young kids also know that you don’t always get what you want. What if you’re establishing your emergency fund and thanks to Murphy, something happens before you’re fully funded?

This isn’t an ideal scenario, but there may come a time when you can’t scrape together enough cash to pay for the ____ (medical procedure, dead car, accident, etc.). What can you do when the worst happens? Well, you could not pay… And deal with the ramifications that follow. Or – you could ask for a personal loan from a friend or family member, take out a home equity loan (if possible), or reach out to a bank about a quick personal loan. Many banks will lend a few thousand up to tens of thousands within a week to borrowers with good credit history.

It’s not a perfect world and sometimes we need imperfect weaponry. Paying interest is less complicated and comes with fewer side effects compared to not paying and defaulting on medical bills (or the like).

Debt and Businesses Finance:

As a disclaimer, business finance vs. personal finance can be apples and mint chocolate chip ice cream (e.g. not in the same realm). While on the family or individual level, debt can produce excess strain, stress, and sleepless nights (the Big-Three). Alternatively, businesses need to see debt through a completely different lens.

4. Starting a business

Similar to the real estate investing example above, we don’t always have the capital required to buy or start a business. For example, my wife and I recently bought a dental practice. Goodwill, tangible assets, and Accounts Receivable aren’t cheap. If the equation of earned income versus monthly expenses is in balance, you would expect this new asset (your business) to earn you more income and ultimately make you wealthier.

Granted, the variables that comprise that equation are more abundant and intricate than I have time for here, but the following holds true. Just like I didn’t have the $100k for the duplex, I didn’t have the ($100k x (X)) for the dental practice. And in order to advance our family’s future income, we chose to open a business using debt. If we were to go the route of “Save up and pay cash” for the business, it’s likely that we wouldn’t have been in the market for at least the next decade.

As long as you successfully conduct your due-diligence and your income equation is in balance, taking out a business loan is an excellent and effective way to break into the entrepreneurial game.

5. Leveling up your business

There may come a time when an influx of cash right now is needed to produce a significant profit later. Examples of this situation are numerous (i.e. launching a new product, hiring, offering an additional benefit to current employees, …, or opening a new physical location).

Our business gave us experience with the latter. Before signing on the dotted line, we were unable to secure a long-term lease with the previous landlord. As a condition of our purchase, then, we needed to find a new location and determine all facets of the plan to build out this new space. It was great that we would have a brand new office.

But… Brand new offices don’t grow on trees. Although we were able to get a discount on the business purchase, we still needed to come up with a significant amount of money to build our new office.

After determining we were out of wealthy relatives and random donations, we were left to secure financing. We took on more debt now to secure the possibility of future profits.

6. When the tax benefits are hard to ignore

Fortunately, there are diverse options available for business owners when it comes to raising additional cash. Depending on the size and type of your business, two common options are to either get a loan or raise equity through outside investors.

Putting aside the other variables (e.g. giving up equity, repayment terms, gaining value through mentorship, etc.), comparing the tax advantages of these two decisions may help determine your decision. The reason: business interest payments are tax deductible.

That is to say that if all other things are equal – if Business A finances with debt and Business B finances through outside investors, Business A will produce higher profitability. All because Business A chose to use debt as a money tool.

Conclusion

We’re not talking about consumer debt, car loans, or Pay Day loans here. I’m not going to plant my money matchup flag on any of those hills. No.

The debt I discuss above encompasses more graduate level topics. Trying to reduce taxable income indirectly or total interest paid in combination with increasing your business cash flow while retaining that precious equity. When you get to decisions at that level, your arsenal requires sophistication.

I’m not advocating that you go out and secure More Debt just for the sake of doing so. Don’t be foolish. What I am advocating though, is for you to understand all of your options, including their ideal circumstances and eventual effects.

Sometimes you need to take a step backward or sideways in order to move forward. Be tactical. Use all of the firepower available to you. This way, you’ll be more likely to keep that white flag in your pocket.

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Now let’s go to Chris from The Cash Dad who doesn’t like debt at all…

Debt: The Burden that You Don’t Even Realize You’re Carrying.

He struggled up the long windy country road. The clink of metal on metal interrupted the otherwise peaceful morning. His companion glanced at him with an inquisitive look. What was he doing? They were supposed to be out for a nice morning walk.

The chains that the man was dragging behind him seemed to be more of a hindrance.

“Why did he bring them along”, his unencumbered companion asked herself. “Couldn’t he leave them at home?”

The man couldn’t take a step to the side or forward without pulling the mess of chains along with him.

All the while he was muttering to himself, “Let’s talk a walk she said.”

“It’ll be fun she said.”

********

You may think this is a ridiculous story, and you’d be right!! I’ve never seen anyone with a bird’s nest of chains tagging along wherever they went: Marley brothers’ style (Muppet’s Christmas carol).

And you haven’t either. And yet, here we as fun-loving Americans are, with over 13 TRILLION dollars in total household debt!!! That’s trillion: with a “T”!!

Debt is just like that chain that you’re dragging along with you wherever you go. You can’t get away from it. It’ll haunt your waking hours and give you nightmares. This is the stuff that horror movies are made of.

And the worst part? Most people think they’re doing just fine – thank-you-very-much. They have no idea how much of a mess they’re in. And they’re so used to dragging that heavy burden around, they don’t know life without it.

Why is Debt so Bad?

1. Debt Payments Restrict Your Cash-flow.

As soon as you sign on the dotted line for that loan, mortgage, car note, or any other type of debt, you’re on the hook to start paying it back. You don’t even get a reprieve. They’ll want the first payment THIS MONTH!

And depending on the type of debt you signed for, your payments could vary depending on the interest rate and balance. Think: credit cards or student loans.

There is only so much room in your budget for loan payments. At some point you’ll be tapped out. And all your money will be going to someone else.

If you had no debt, just think of what you could do with all that extra money you have. You could be investing and saving, or traveling. But you’ve restricted your monthly cash flow with debt payments, because you couldn’t delay gratification.

2. You Can Never Have Freedom With Debt.

When you have debt, you’re always in bondage to someone. Your lender will always have power over you. That’s part of the agreement you entered into when you signed. They could call your debts, leaving you in some deep trouble.

The Bible says, “The borrower is slave to the lender.”

A slave doesn’t have freedom. We’ve already discussed how your income is earmarked for their bank account instead of yours in the form of payments.

You’re free to use some of your income for your pleasure and gain, but never all of it. You’re a slave to your lender and debt.

3. If You Have to Use Debt, You can’t Afford it.

The thought process that we go through before we borrow money goes something like this.

“I want to buy ________ “- fill in the blank. House, car, boat, college education, vacation, or even furniture.

“That “thing” costs X number of dollars. I don’t have X number of dollars.”

“I can’t wait to save up the money. I’ll go talk to someone who does and borrow it from them. And so, what if I have to pay it back over the next 30 years. That’s called leverage, and it’s what all the smart, rich folks are doing.”

No, that’s called dumb!! And for every “smart, rich person” you see doing that, there are 50 more people trying to the same thing, and failing miserably. And ending up in bankruptcy and losing everything.

Because they couldn’t afford that “thing” in the first place!!

Conclusions

Personal finance comes down to behavior and attitude. The numbers and math are secondary.

If we could understand that our future is built on our choices today, we might make better choices today.

Choosing to never borrow money again is one of those choices.

Debt restricts your cash flow and robs you of freedom.

People around you may not ever see the chains of debt you’re lugging around with you. But you know they’re there. You can feel them. And you know that if you had never signed for that debt, you would be in a much better place right now.

But there is always hope. You can start today to turn things around. Make a list of your debts, and start attacking them one-by-one. And once you’ve freed yourself from the chains of debt, NEVER EVER GO BACK!!

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So, those are the two sides of the issue. What do you think?

ESI is the owner of Rockstar Finance and writes at ESI Money, a blog about achieving financial independence through earning, saving, and investing (ESI).

He’s an early 50’s retiree who achieved financial independence, shares what’s worked for him, and details how others can implement those successes in their lives. He is also the author of a free ebook titled Three Steps to Financial Independence and spends a lot of his time interviewing millionaires.

Last modified: May 13, 2018

8 Responses to :
Money Match-Up: Is Debt a Money Tool or Some Form of Evil?

  1. Mouse says:

    I tend to side with Cash Dad and refrain from taking debt. I think it’s too easy for many people to convince themselves that taking on “good debt” is going to make them wealthy in the end. Which, when it works is great, but as with all leverage we find out who is swimming naked when the tide goes out.

    Mike does bring up some good examples, and I don’t reject all debt on principle, but I think increasing your debt burden is a sober decision that should be approached with care.

    Thanks for sharing this nice point/counter point format, I enjoyed the read.

  2. Rohan says:

    I’m fairly split between the two. Mike makes some good arguments about good debt and how it can be used as a tool. I have seen my parents do that through their life with real-estate and property investing. To quote them “don’t be afraid of debt, learn to manage it to your advantage”.

    But Cash Dad also makes a good point. You can’t ever be totally free if you have debt. You are slaved to those payments.

    My strategy is to use debt to get a higher education and home- to pay them off as fast as possible to gain financial freedom. I think renting while saving at the same time is a slower path than buying and paying a mortgage.

  3. Kate says:

    I side with The Cash Dad for staying debt free. I agree that once in debt you are a slave to it. No freedom as long as you owe someone else. I don’t think that debt is worth the risk just to use it as an investment tool. It poses more risk verses traditional investments.
    Great Argument.

  4. Scott says:

    What stage of life you’re in definitely has to drive the use of debt as a tool. While I do see the advantages of using debt to build towards future gains, I’m pretty averse towards debt as I see first hand how much of a burden it puts on day-to-day life. Once we’re debt free, I’ll reassess the use of debt to make advances in our FI plan. It would be very imprudent of me to even think about it right now.

  5. ZenTheFrenzy says:

    If debt is going to weigh on you like chains then you should probably avoid it. I tend to think of things in terms of the net position. If I have cash invested elsewhere that would cover the debt, then I have just chosen a strategy for managing finances. I don’t even have a problem with using leverage if people understand what they are committing to. If you’re intentional about your finances, debt is a tool. If you are not intentional then it’s dangerous.

  6. We’ve got some solid comments here and I’m glad to see that. I recognize that my portion was probably the unpopular side of this argument given the forum, but I’m happy to see that most of you have considered the option. In a perfect world, we’d pay cash for everything but if life has taught me much it’s that sometimes you need to get creative.

    Thanks for checking out post out and for considering both sides. Appreciate it!
    -Mike

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