When Should I Use Debt?

[Brady Mullen]

It's undeniable that debt has the power to consume. Anyone who has let credit card debt run amuck can attest to this.

I'm writing this from a place of humility. I have learned some of these lessons the VERY hard way.

But debt can also be a useful tool.

Think about how difficult it would be to get out of the renting cycle and own your home if it weren't for debt (mortgage).

Many smart businesses use debt tactically and strategically to stay nimble and flexible with their resources.

My point here is not to cast a vote for or against debt - it's too nuanced a subject for that type of judgement. I would like to offer some ideas on how to think about it properly and how to control it.

I think of it like fire - incredibly useful and incredibly dangerous.

For starters, my first test a debt would have to pass before I'd consider it would be if the debt will reliably provide the means to repay itself.

For example, if I get a 70% mortgage on a rental property, and if the income will cover the debt obligations, then this is something entirely different than borrowing money to purchase an expensive car just to impress people.

Debt to produce the income to pay for itself not the only metric I'd look at, but it's a good place to start.

This counts for education, too.

If I am pursuing a well-paying job that I can expect to get after completing the required degree, then debt might be a useful tool for that. And if that job provides me the additional income to pay off that debt, then I can see a valid argument for this.

However, if I want a career that pays roughly $60,000 but requires a degree that costs me $80,000, using debt for this seems like chaining a ball to my foot that will be very difficult to remove.

You can get a $60,000/yr job without a degree. If you're skeptical of this, you're either not thinking hard enough or unwilling to consider certain types of very respectable work. Think trades… $60,000/yr is the low end for many of the trades.

If I REALLY wanted that career that required the degree for personal reasons, then there is nothing wrong with pursuing it! But I'd try to get that degree without the debt. It would fall into the "luxury" category, which should not be acquired through debt.

Anyone else got any metrics they use to determine whether a debt makes sense for them?

[Ricardo R.]

@Brady Mullen Debt is used for --> Appreciating Assets and assets make you --> Money, preferably immediately and/or on a recurring basis. EVERYTHING ELSE is not a use for debt. 

That is the only measuring stick you need and you can apply it to real estate, education, transportation, everything. 

[Brady Mullen]

Quote from @Ricardo R.:

@Brady Mullen Debt is used for --> Appreciating Assets and assets make you --> Money, preferably immediately and/or on a recurring basis. EVERYTHING ELSE is not a use for debt. 

That is the only measuring stick you need and you can apply it to real estate, education, transportation, everything. 

 Well said, Ricardo. :)

[Chris Seveney]

@Brady Mullen

Simple. Use debt that provides a low loan constant and if I am taking it against equity on something I need to make sure that money provides a greater return than my interest rate

For example a car loan at 4% is ok because i can invest that amount and net more than 4%…

[Kevin Hintz]

I completely agree with your view of debt as a tool, albeit a double-edged one. In my personal experience, I've also considered the rate of interest as a criterion. High-interest loans, like most credit cards and personal loans, became a no-go as they don't provide value in the long run. On the other hand, low-interest debts, like student loans or mortgages, can be justified provided there's a robust repayment strategy and forecast of steady income.
An additional metric I use is the 'opportunity cost'. Borrowing might make sense if it allows me to take advantage of investment opportunities I'd otherwise miss.
Even with these types of guidelines, managing debt can be challenging and complex. That's why I use the help of a professional. I'm working with a bankruptcy lawyer in San Diego (where I currently live) who is instrumental in guiding me through all my financial hiccups. It provides a safety net, knowing I have an expert watching my back financially, so I recommend you all get one ASAP.

[Jaron Walling]

Anyone using debt effectively understands the difference between assets and liabilities. 

When you don't understand the difference you use debt wrong and get perpetually trapped in the middle class. 

Examples; auto loans, student loans, car leases, HELOC (no strategy), credit cards (running balances), and personal loans. For the most part none of these create a return. None generate an income. None of them build equity. None of them are tax advantaged.

[Dan H.]

Quote from @Jaron Walling:

Anyone using debt effectively understands the difference between assets and liabilities. 

When you don't understand the difference you use debt wrong and get perpetually trapped in the middle class. 

Examples; auto loans, student loans, car leases, HELOC (no strategy), credit cards (running balances), and personal loans. For the most part none of these create a return. None generate an income. None of them build equity. None of them are tax advantaged.

 Note the property primary dictionary definition of asset has nothing to do about creating a return.  Robert K self defines a word and it is taken as fact.  The definition of asset as something of value is something most middle schoolers understand but many readers of RDPD do not. 

In addition, an item can be both an asset and a liability.  Example is many new luxury vehicles but Robert K treats them as mutually exclusive (which they are using hid definition).  Going to have to make.

[Denis Ponder]

Quote from @Kevin Hintz:

I completely agree with your view of debt as a tool, albeit a double-edged one. In my personal experience, I've also considered the rate of interest as a criterion. High-interest loans, like most credit cards and personal loans, became a no-go as they don't provide value in the long run. On the other hand, low-interest debts, like student loans or mortgages, can be justified provided there's a robust repayment strategy and forecast of steady income.
An additional metric I use is the 'opportunity cost'. Borrowing might make sense if it allows me to take advantage of investment opportunities I'd otherwise miss.
Even with these types of guidelines, managing debt can be challenging and complex. That's why I use the help of a professional. I'm working with a bankruptcy lawyer in San Diego (where I currently live) who is instrumental in guiding me through all my financial hiccups. It provides a safety net, knowing I have an expert watching my back financially, so I recommend you all get one ASAP.

I don't understand this.  You are suggesting people spend money on a bankruptcy lawyer, and a retainer to keep one from what it sounds like, to help manage debt?  What is so complicated about debt you would need to incur this level of expense?

If you are going through something financially which is leading you to bankruptcy, I can see the benefit of having someone help you out.  But to suggest everyone have one?  Most people don't need this at all.  Have a budget for your money, be disciplined, don't be a consumer (expensive clothes, cars, etc), save, invest.  It's math.