Can Debt Help You Accomplish Your Financial Goals?

Contrary to what many people think, there’s such a thing as good debt. There are certain purchases and financial goals that offer good return of investment (ROI), such as mortgages, student loans and auto loans. You can even improve your credit profile if you manage your debt responsibly and make payments on time. However, good debt may not be for everyone, especially if making payments is a challenge. Learn more about what good debt entails and how to use it to your advantage.

While many Americans struggle with debt, there are certain types of debt that can be considered good to have. Generally, good debt helps generate income, build net worth and achieve financial goals. Understanding how it differs from other types of debt can help you make better financial decisions.

Borrowing money is sometimes necessary. If it helps increase your net worth or can be considered an investment with future value, it can be categorized as good debt. These include mortgage, auto loans, student loans and small business loans.

While accruing debt may be worth it since you are investing in your future, it may not be the best option for everyone. It’s important to consider your needs and circumstances.

Knowing how to differentiate between good and bad debt can help you make better financial decisions. If the debt shows growth potential, is an investment or the monthly payments are worth it, the loan is considered good debt.

On the other hand, loans for low-value purchases and unnecessary items are categorized as bad debt. If the loan provides you with short-term relief but is costing more over time, it's bad debt.

Knowing what types of debt are good and which are bad can help you protect your financial health. The following are some common examples of good and bad debt to help you in differentiating them.

Choosing good debt can help you manage your finances more effectively. It can also leverage your wealth since it helps you purchase things that can improve your financial health over time. That said, it's important to understand taking on debt comes with potential risks. Depending on your debt tolerance, even good debt may not be for you. Make sure you understand the terms of a loan before deciding to borrow money.

Most, if not all, Americans dream of owning a home. Aside from having a safe place for you and your family to live in, owning a home builds equity. However, purchasing one can be expensive. That’s why many consider taking out a home loan. According to the Federal Reserve Bank of New York, mortgages contribute to 70% of household debt in the U.S.

Take time to understand how you can best use a mortgage, what your limit should be and how much you can afford.

During the last quarter of 2021, the average sales price of homes sold in the country was $477,900. That’s 18.32% higher than the average cost of $403,900 in the last quarter of 2020. Meanwhile, the 2020 year-end average saw a 5.02% increase from the average price recorded in 2019.

Let’s say you bought a $384,600 home in 2019 using a $334,600 mortgage with 3.5% interest rate and $50,000 down payment. A 20-year fixed loan term would cost $1,941 monthly, which covers the principal amount and interest. Throughout the next few years, as detailed below, your home loan amount decreases while your equity increases.

Generally, obtaining your college degree can help increase your earning potential. That’s because you’re qualified for higher earning professions.According to the Bureau of Labor Statistics, the median weekly earnings for people with a high school diploma is $746. In comparison, having a bachelor’s degree can increase that to $1,248.

However, pursuing a higher education degree may not be affordable for everyone. That’s where a student loan can be helpful. It may also come with an opportunity cost — what you might sacrifice from doing one opportunity instead of another. For example, taking out student loans and acquiring debt versus working full time and increasing your savings.

Although student loans are good debt, you should also be aware of the risks. While there are student loans with low-interest rates and tax-deductible interest, inability to pay off the loan within the terms could be detrimental.

Before you decide to obtain a student loan, it's important to understand the advantages and risks. Learn more about some of the potential benefits and opportunity costs of getting higher education.

A mortgage can also be used when investing in real estate. There are several types of real estate investments, such as rental, commercial, retail, industrial and residential.

Some people use a mortgage or loans for real estate due to its potential to gain higher ROI rates. It also allows them to have multiple investments at the same time and helps leverage wealth in the long-term.

Make sure this option is right for you and consider the possible risks. Otherwise, this investment can turn into bad debt.

Starting a business requires money, time and effort. You will need to come up with enough capital to cover the initial expenses. Aspiring entrepreneurs who do not have the financial capacity to launch their dream business can opt to take out a loan. Depending on your needs and circumstances, the best loan option may vary. For instance, the most common loans for startups are small business loans and personal loans.

But before you decide on a loan, make sure you understand the requirements, steps and potential risks.

Taking out a loan to start a business is not something new. In fact, many successful entrepreneurs in today’s market started small. However, this method does not apply to every business. You have to make sure you understand the potential risks of using a loan to launch your business — failure can lead to a huge debt that is hard to pay off.

There are various ways to build wealth using good debt. One of these is through the home equity line of credit (HELOC). Generally, HELOC is a type of revolving line of credit taken against a home. With this, you can get a maximum loan amount with interest. Instead of one lump sum, you can use the HELOC whenever you need it.

HELOC can be used in different ways. For instance, you can get money for renovation, education, investment or debt consolidation.

Getting a HELOC can be advantageous. For some homeowners, it can be a smart move. However, depending on the circumstances, getting a HELOC may not be the best fit for you because you’re putting your home on the line. Make sure you weigh the pros and cons before applying for a HELOC.

For some people, borrowing money is a great way to earn money. That may be true in some cases. With good debt, you can build your wealth and maximize the returns on loans. However, you have to make sure that you are using debt responsibly. Create a clear plan and determine your objectives.

Investing can be a powerful tool to build wealth. If you do not have enough money to access a good investment, you can opt to borrow a modest amount. Then, invest the money. For instance, you can use it to purchase a real estate investment property.

That said, there are many factors you need to consider. Research tax implications. Paying off a debt will not only require you to prepare the amount you borrowed. You have to pay interest rates. There will also be taxes on the amount you settled.

Many consider the leverage they could achieve when using debt for investment — when you use the money you borrowed to increase ROI. It helps you achieve the returns you are aiming for. The following are some various methods to build wealth by leveraging debt.

Borrowing money can help you start your investment journey to build wealth. Let’s say you decide to borrow $50,000 for your investment portfolio. A 20% gain in your portfolio will lead to a $10,000 return.

Now, if the interest rate for your loan is 5%, you will only need to pay $2,500 in annual interest. Since your portfolio has earned $10,000, you can pay off the interest and still have $7,500 in returns.

This only applies for a year. The money you borrowed and invested is still at risk.

Good debt can help with debt consolidation. It’s when you avail one huge loan so that you can pay off multiple smaller debts. This is a great strategy to address high-interest debts such as credit card and medical debts.

There are two types of loans you can use for debt consolidation. The first one is a secured loan, where you use a personal asset as collateral to fund the loan. The second option is an unsecured loan. With this, you can borrow money without collateral. However, unsecured loans typically have higher interest rates compared to secured loans.

Debt recycling offers a way of managing debt to build wealth. This strategy includes paying off non-deductible debt, such as a home loan, to recycle it as a tax-deductible debt.

With proper execution, debt recycling can help you start investing without having a financial source. It can also help pay off your mortgage earlier than planned.

However, it's important to understand that debt recycling is not for everyone. It comes with potential risks. For instance, if you use the existing equity of your home, you risk losing it. Additionally, your investment may not incur income and even end up in losses.

Debt can be a good thing. It can help you attain your financial goals and even build your wealth. But debt also comes with responsibility. You have to make sure that you can manage your payments well. A solid financial plan and adopting good money management skills can help ensure that good debt will not turn into bad debt.

Debt, even good debt, is not for everyone. Before getting a loan, you have to weigh the pros and the potential drawbacks that come with it. Aside from your finances, your well-being can also be affected by having too much debt.

Knowing your debt tolerance can help you figure out how much debt is too much for you. Calculate your debt-to-income ratio. Check your credit utilization. It’s also helpful to know your comfort borrowing level.

Good debt can turn into bad debt if you fail to manage it properly. But when is debt considered too much? The following are some signs you can watch for to determine whether you have too much debt. Recognizing these early can help prevent more financial problems.

The reasonable amount of debt load may vary per person. That is because of differences in financial situations and circumstances. Generally, using the 28/36 rule can help you determine how much debt you can handle.

The 28/36 rule is a way to calculate the amount of debt an individual should assume. According to this rule, you should only spend 28% of your income for household expenses. For debt service, the total should not exceed 36% of your gross monthly income.

Aside from this method, you can also calculate your debt load tolerance through the following:

Sometimes, managing debt requires professional support. That is especially true when your debt becomes a burden. Aside from the financial implications, debt can also affect your mental health. In such cases, the best option is to seek help. The following tips can be started immediately to properly manage your debt.

Whether good debt can help you or not depends on your circumstances. The following resources and tools can help you better understand how to use good debt to your advantage.

• Banks: Financial institutions offer loans. Depending on where you plan on using the money, you can get good loan opportunities with fair fees and interest rates. Talk to your bank to learn more.
• Federal Student Aid: If you are looking for grants and aids to finance your education, you can check the Federal Student Aid website. Here, you can find options to pay for your studies.
• Federal Trade Commission: Be aware of various frauds and scams that target consumers. Find out how you can prevent falling victim to these scams and protect your finances.
• GovLoans.gov: Use this online resource to find government loans. Check the eligibility requirements for different types of loans.
• Kabbage: This online resource gives access to different tools you can use to grow your business. Find funding options and apply in minutes.
• National Small Business Association: Learn more about running a small business. Get updates on legislations, find business insurance providers and see how NSBA partners can help your business.
• Personal Loans USA: The company helps connect borrowers to lenders. Simply submit your loan request and wait for interested lenders to contact you.
• Small Business Administration: If you are interested in starting a company but you do not have enough capital, you can get help from SBA to access a loan.
• Small Business Development Centers: The SBA funds development centers to offer counseling services to local businesses and entrepreneurs. Find a development center by entering your ZIP code.
• USA.gov: Learn more about different government programs and find grants and loans suitable for your financial needs. You can also check the requirements on their website.
• US Department of Housing and Urban Development: If you want to own a home and are looking for loan options, check out the US Department of Housing and Urban Development and find out more about FHA Loans.