3 Ways To Use Debt To Build Wealth

Posted by Jake Sadler on May 02, 2022

Though it may seem counterintuitive, some financial concepts we’re taught to think of as “bad” can actually be used to help achieve our long-term financial goals. One of these concepts is debt.

Debt, in the simplest terms, implies a financial obligation to a loan holder or financial institution—or, in other words, you accrue debt when you borrow money and owe it back. On the surface this arrangement may seem like a burden, but when used properly, debt can be a powerful financial tool. Below, we’ll explain how debt can potentially be used to build wealth in three different ways.

How To Use Debt To Build Wealth: Three Strategies

Strategies to build wealth using debt are distinctly different from the use of debt to “live above your means.” In this context, wealth building strategies are primarily limited to non-consumer debt, or debt used to purchase assets that will increase in value. This type of debt is also occasionally referred to as either “good” debt or business debt. While you shouldn’t enter into any loan or obligation lightly, non-consumer debt can be used to strengthen your financial position over time.

1. Purchase real estate with a mortgage.

Real estate can be a great wealth-building strategy for high net worth individuals. But no matter what your financial situation is, you need a roof over your head—and buying a home is a valuable way to gain one.

Even if you are in a position to buy real estate in cash, it’s sometimes more effective to use a mortgage (assuming you get a good interest rate and favorable terms). You can use a home mortgage to gain tax deductions and better monthly payments than you possibly would via renting. You can even amplify your passive income and gain financial freedom by renting out your newly-purchased property. Whether renting or living in your real estate, you will likely be growing your net worth over time as you build equity in your property.

Note: When using debt to build wealth in real estate, be aware of your own financial limitations. Your mortgage lender will likely have their own debt-to-income ratio they’ll use to approve you for a mortgage, which could be as high as 36-40%. However, a healthier, self-established ratio for you might be closer to 20%. Stick to your chosen ratio; don’t purchase more property than you can afford. And if you’re purchasing a property with the intent to rent it out, make sure you can pay the mortgage on your own should it remain empty for any length of time.

2. Use commercial loans for your business.

If you have a business or are starting one with a well-developed business strategy ready to implement, there are commercial loans available that could allow you to start or keep growing a business without using too much of your current cash. To open a commercial loan, you’ll often need to establish a relationship with a local bank lender or an expert who can help you apply to the Small Business Administration (SBA).

While the terms of this type of debt are unique to your business, your financial situation, and your planning, it can be beneficial in that it allows you to:

  • Purchase better business equipment and inventory from the start
  • Pay initial employees a higher wage, helping you to attract top-quality candidates
  • Gain tax benefits by deducting business expenses
  • Use borrowed money to pursue business profit, preserving your own funds for personal purposes

3. Leverage your human capital: get an education with student loans.

You may be surprised to see this type of debt listed under “good” strategies, but it’s true—student loans can be an investment in a valuable asset: your human capital. In other words, they help you work on yourself and your own skills. When you invest in education by taking out student loans, you unlock the potential to pay off your loan in the future with dollars that will likely be worth more at a later date. Your higher education can also increase your earnings, meaning—if planned wisely—you’ll be able to pay off student loans with greater ease in the future.

Be Cautious Of These Types Of Debt

There are, of course, many types of bad and unadvisable debt. These include:

  • Consumer debt: debt used to buy consumable, non-appreciating items
  • Speculative loans: borrowed money used for speculative investments
  • Margin loans: money borrowed against the value of your current investments

Under the right circumstances, however—and with guidance from a knowledgeable financial professional—even the debt listed above can be used to gain tax breaks, provide cash flow planning opportunities, or build up valuable cashback rewards. But most often, these types of debt are riskier and aren’t used to purchase reliably wealth-building assets.

Leverage Debt Carefully For Financial Security

Using debt to build wealth comes with both pros and cons. Remember: Whether it’s labeled good or bad, debt can amplify both gains and losses. For any loan you’re considering, it’s critical to evaluate its terms, interest rates, expected repayment deadlines, and true costs over time. If the potential losses will jeopardize your other financial positions, proceed with caution.

If you want guidance from a trustworthy financial advisor on using good debt to build wealth, schedule a call today with one of our advisors at BayPoint.

Schedule A Call - Bay Point Wealth

Topics: Financial Planning, Wealth Management