If you’re looking for ways to improve your financial situation, you might think that paying off debt is the first step. While it’s a smart move to pay off high interest liabilities, being debt-free isn’t necessarily the promised land.
Contrary to popular advice, debt is not intrinsically evil. It can serve many purposes and help you reach your goals. In fact, some of the wealthiest investors have used leverage (debt) to build out their portfolios.
While there certainly is such thing as bad debt, not all debt is bad debt. If you’re familiar with our method of making financial decisions, we tend to wage interest rates against one another—similar to a teeter totter. It’s all about assessing your interest rates and making your decision based on the numbers.
Let’s look at an example. Typically, a great real estate investment will make around a 10% return. Let’s pretend you have a large amount of credit card debt averaging around 22%. In this scenario, if you’re deciding whether to use funds to pay down debt or invest, you’ll likely want to take a swing at the high interest debt first.
However, if you don’t have the high interest credit card, but you have a student loan around 5%, we’d typically advise you to put your money into an investment that can perform for you, since 10 is greater than 5. Focusing on paying down low interest debt isn’t usually the best move if you can instead use those funds to build wealth.
But what about taking on debt in order to invest? Again, it’s all about playing the interest game. Using credit to purchase real estate can be incredibly beneficial, as long as the numbers make sense.
Consider a situation in which you’re planning on purchasing a property with a HELOC. Let’s say your HELOC has a 4% interest rate. As long as your investment brings in more than 4% ROI, you’re still making money. Another point to consider is in this scenario, your tenant is paying off your debt.
Making your decisions is all about evaluating your financial products in order to determine what can best help you reach your goals. We believe that there is not a one-size-fits-all approach to finances. Just because a financial guru preaches a strategy, doesn’t mean it will be right for your situation.
That’s why we don’t emphasize being debt-free. Instead, we’re more focused on being financially free. Achieving financial freedom means having all of our expenses covered, regardless of your job or paycheck. That's why we created the Freedom Cheat Sheet. It's a free PDF you can use to calculate how much passive income you need for your particular situation.