Debt: Build Wealth by Being Smart About It

Summary / tl;dr

When utilized well debt can be a useful tool in building wealth.

Low interest rate debt is better than high interest debt.

< 5% → Generally good

5% - 10% → Good if utilized well (to buy assets, higher education etc)

> 10% → Generally bad

Buying appreciating assets with low interest loans is generally a good idea.

Debt..let’s talk about it!

Having debt is normal. It could be as minor as owing a friend for a meal or as major as a student loan or a home mortgage. Debt is commonly talked about negatively, but have no fear…. It’s pretty normal to have debt. Most of us can’t afford everything right away, and frankly, life is expensive! As long as you have a solid plan to pay it back, debt allows you to acquire some joys sooner and pay for them over time.

The bigger picture is that you may need to sacrifice some money in the near future to make more money in the long term. That is a vital skill in wealth creation. The question is… what debt is valuable to have, and how much debt is too much?

Good Debt - Home Loans, Education Loans, Low APR Auto Loans

Anytime that you can responsibly pay off a debt within the agreement and have a good return on the investment, it’s perfectly okay to take on the debt!

Home loans. Low interest car loans. Commercial real estate loans. Generally any loan under 5% interest rate per year. If a choice is between paying a small interest payment or paying a large chunk of money upfront, the math generally supports taking a low interest loan and investing the rest of the money into an investment that is likely to return decent returns over the long run (say S&P 500 index fund). This is especially true when you are young and you believe that your income is likely to increase in the future.

For example, it’s common to correlate having a higher degree with receiving a higher income. Taking a student loan, which is a type of debt, may seem like a burden at that moment, but in the long run, you have a higher possibility of getting a higher income. That will help you build your net worth in the future!

A similar example is home mortgage. You most likely will borrow money to buy a home. As you pay that debt off gradually through a mortgage over time, there is a high chance your house will be worth more at the end.

Bad Debt - Credit Card Debt, Payday Loans, Excessive Margin Loans

Imagine you really want the new gadget but don’t have the money for it, so you charge it on your credit card. You realize you are not able to pay back the full amount on the statement, and have that additional 27% interest rate on the remaining balance.

This would be a bad debt because you don't get a good return, the item isn’t increasing your wealth, your credit score might go down if you miss a payment. What a lot of people don't know is that once you start paying off your debt, you are first paying off your interest and then your principal most of the time.

In general, anything with interest rates over 10% per year, like payday loans, is not a great idea.

Margin loans over 20% of your investment portfolio value can also become bad debt very quickly, especially in a downmarket that we are in now.

Debt Consolidation

Having multiple loans with different due dates, interest rates, term limits etc can put a huge cognitive load on your brain, and could potentially cause issues such as missed payments. Consolidating all the loans every few years reduces this cognitive load and also improves financial terms. For example, consolidating education and car loans into cheaper home equity or home refinance loans could reduce monthly payments and increase your savings rate and correspondingly your wealth.

Using Xillion to Manage Debt & Build Wealth

Xillion can help you pick the best financial choices to debt. All these debts have effects on both your short term and long term financial worth.

“During a period of hefty decision making such as buying a house, going to grad school, or leasing a car - having the wise counsel of the expert Xillion mentors helped us realize that debt isn’t as evil as society makes it to be.” - Xillion Customer

Explore our products & blog at Xillion - Wealth Management for Everyone!. Together we can optimize your debts with 1-1 mentoring from experts.