Marsha Welch | January 13, 2023
Summary: The main difference between good debt and bad debt is how the value of your purchase that puts you into debt changes over time. Consider the difference between a mortgage debt and a credit card debt; one has the potential to generate wealth over time, while the other can cause you to fall even deeper into debt with interest rates and fees. You can use debt to build your wealth when you borrow money to invest, replace inefficient debt with efficient debt, consolidate your debts, use debt to start a business, and use a house flipping strategy.
While some people are wary of debt, others gladly use loans for both major purchases and regular needs without considering the consequences. You may wonder what strategy is better for building wealth, and the right answer is "something in between."
In fact, not all debt leads you to stress and ruins your life. On the contrary, some types of borrowing money can create passive income, help you improve your budget management skills, or even reduce your existing debt. But most people still don't understand how to use debt to build wealth and stay away from both good and bad debt.
If you wonder how debt can create wealth, the answer is on the surface. If you use the money in ways that enable you to build wealth, borrowing money might be beneficial. On the other hand, borrowing money might be detrimental if it leaves you broke and in debt. Below, we describe several debts and how you might use them to your advantage.
The short answer is yes, it is possible. However, you need to keep in mind that not all debt will improve your financial situation. On the contrary, some debts with high interest rates can trap you and result in various financial difficulties over time.
That being said, you can use other debts for your benefit, for example, purchasing an investment property. These types of debt can help you build wealth by using the income generated from assets to make loan and interest payments and manage the rest of your cash flow to make more investments.
Thus, when you're going to get a personal loan, ask yourself what your borrowing goal is. Of course, it's not always possible to be pragmatic. Sometimes you may get into a financial emergency and need to borrow money to cover your current expenses or regular spending. This way, you won't reach financial success but will be able to cope with financial difficulties without stress.
However, when it comes to building wealth, you need to have a plan or a long-term strategy, estimate all risks, and have a clear understanding of what good and bad debts are.
There are several factors that determine whether a debt is considered good or bad. Knowing these factors will help you differentiate between good and bad debt. As you probably have guessed, the main distinguishing feature lies in what you're going to spend the money on and how the value of your purchase changes over time.
Besides the way you use your loan funds, there are a few more factors that differentiate good debt from bad debt. The following two metrics are the annual percentage rate and the period of time it will take you to pay off your loan. In addition, your particular debt tolerance and risk tolerance should both be taken into account. But let's take a closer look and give several examples for a better understanding.
Good debt, also known as efficient debt, is a type of obligation you use to make purchases that have the potential to generate long-term wealth for you. This way, you can consider it as a part of your investment strategy. It allows you to put money into appreciable assets and get some benefits from it over time. A home loan is an example of good debt as it allows you to get an asset that will bring you benefits in the end.
A form of obligation with a high cost or a high level of risk is referred to as bad or inefficient debt. Credit card debt is the most prevalent type of bad debt. It is considered so due to its high cost and the way most individuals use their credit cards to make within-credit purchases. Another example of bad debt is a car loan. It is considered bad because you borrow money to purchase a depreciating asset that will only lose value over time.
In summary, good debt is a borrowed amount that you get on reasonable terms and use to build long-term wealth. In its turn, bad debt is a type of borrowing that bears only the debt itself that reduces your wealth because of associated interest and additional charges. Bad debt doesn't come with any profit you can gain with time.
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You can take a number of actions to manage your personal finances so that you can begin using debt to make money and help you advance your financial goals. Below are the top five ways to build your wealth through debt:
Creating passive income streams by using good debt is a strategy that professionals use to build real wealth. There are various investment strategies that can help you with this. You may have even heard of margin investing, leveraged ETFs, hedge funds, and short selling before. Sometimes using debt can help you get several times more annual returns than if you used only your own money.
Use a debt recycling strategy that aims at helping you replace your bad debt with one that generates capital growth or is tax deductible. For example, when you use equity in your house, you can invest in assets that might produce income and potentially grow in value.
Debt consolidation can help you reduce your overall interest payments by combining several higher-interest debts into one. When you consolidate your debt, it turns multiple loans into one single loan. This strategy enables you to pay off all of your debt in one large monthly payment, rather than juggling several debts.
The purpose of debt consolidation is to make your debt management easier. If you have one payment, it will be easier to focus on and pay off that debt. Typically debt consolidation allows you to lower the interest rate, reduce your monthly payment, and ultimately pay off your debt quickly.
Check out our guide on debt consolidation and its pros vs cons.
You can use good debt as an auxiliary tool to start a business. If your business becomes successful, it will generate income and create wealth. If you just started your way toward becoming an entrepreneur, it may be difficult for you to qualify for a conventional business loan until you're in business for at least six months. Therefore, a personal loan can help you get started.
House flippers are people who purchase houses, make all the necessary home improvements, and resell the property for a profit. This way, buying a house can also be considered an investment. You can purchase residential real estate with the help of a loan, fix it, and rapidly flip it for a profit. Although this approach comes with risks, it can help you create wealth if you know what to do.
Obtaining debt can sometimes play into your hands. However, if you want to use debt to get rich, you need to have a plan along with a clear understanding of what type of debt you should use to reach your goals. There is no simple answer on how to use debt to build wealth. It's always a personal choice that is based on your particular situation. However, there are a few options that can lead you to the desired output.
When you decide to use debt to make money, don't forget about cash-flow management. If you're a beginner, seek a financial adviser to choose the right strategy. Also, keep track of your debt-to-income ratio to make sure you don't overburden yourself.
If you find yourself in a position where your debts have become overwhelming and unmanageable, SoloSuit can help.
When debt collectors come knocking, send a Debt Validation Letter to stop them in their tracks. Federal law requires all debt collection agencies to verify a debt within five days of initial contact with a debtor. To validate a debt, they must provide the following information:
If you want to dispute any part of the debt, sending a Debt Validation Letter to the collector forces them to gather the necessary evidence to prove the debt is legit. If they can’t, they must cease communication and leave you alone.
Let’s consider an example.
Example: Robert receives a letter from LVNV Funding, claiming he owes a credit card debt of $5,000. After doing some investigating, Robert believes LVNV is wrong and that the debt was already paid off. Robert uses SoloSuit to draft and send a Debt Validation Letter to the debt collection agency within 30 days of receiving the first letter from them. After some investigating, LVNV Funding realizes that the debt is no longer valid and their records were inaccurate. Robert is off the hook, and LVNV Funding ceases communications with him.
Check out this video to learn more about how a Debt Validation Letter can help you fight of debt collectors:
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You can use SoloSuit to respond to a debt lawsuit, to send letters to collectors, and even to settle a debt.
SoloSuit's Answer service is a step-by-step web-app that asks you all the necessary questions to complete your Answer. Upon completion, we'll have an attorney review your document and we'll file it for you.
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Out Debt Validation Letter is the best way to respond to a collection letter. Many debt collectors will simply give up after receiving it.
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