Debt can get you into a lot of trouble, as the financial crisis illustrated with an exclamation point, but it’s not all bad.
“[T]here are times when taking on reasonable debt is the only way to meet your larger goals,” said J.D. Roth, an “accidental personal-finance expert” and author of the popular “Get Rich Slowly” blog.
Roth knows all too well about debt: He calls himself an “accidental” expert, as he learned the hard way after racking up a large amount of debt and digging himself out.
The trick is to know when — and how — to use debt.
“Don’t use debt to buy things you can’t afford,” Roth cautions. “Use it instead to help meet your goals.”
“I often say that debt is like a chainsaw,” he said. “A chainsaw can be a great tool to help you deal with big problems that might otherwise seem impossible to tackle. But if you’re not careful, a chainsaw can kill you.”
“Being responsible with your credit is very important,” said Stacy Francis, a personal financial adviser and founder of Savvy Ladies, a group aimed at educating women about money. “It can take your life to the next level if you’re smart about it — or it can destroy it.”
How you use debt (Do you pay your bills on time? Are you carrying too much debt relative to your income?) is crucial to defining your credit score, which is the basis for all of your financial activity throughout your life.
“Like it or not, all sorts of organizations use credit scores to evaluate your potential — not just the odds that you’ll repay a loan, but also the chances that you’ll pay your rent or be a good employee,” Roth said.
And, since the financial crisis, credit scores are more important than ever in determining whether a lender will extend credit — or not. One in ten people said their credit limits had been lowered in the past six months, according to a recent Consumer Action poll.
Here are five ways that debt can be good for you.
It can help make you money. “Debt, when handled responsibly, can help you invest in an appreciating asset, whether it’s a home or your own education,” said Greg McBride, a senior financial analyst at Bankrate.com.
If you’re smart about where and when you buy a home, the value will appreciate, leaving you with a nice profit when you go to sell it, even if you hadn’t already paid off the mortgage in full. The same goes with college: If you get an advanced degree, it can take your career — and your salary — to the next level.
You have to do the math, cautions Francis. If you spend $200K on an education and you get a job that will pay you $60K, that may not be the wisest investment.
“The main thing is to not use debt as a crutch,” McBride said. “The definition of good debt is something that’s going to bring about greater value later — not pay for consumption,” he said.
It can be cheap. When interest rates are low, taking on new debt makes more sense than liquidating other higher-returning investments to pay for something, McBride explained.
So, instead of borrowing out of your 401(k) or cashing out some of your stocks and bonds, you take out a new loan at a low interest rate. Not only are you preserving your return on those other investments but also avoiding any taxes you might incur as a result of cashing them out.
It can be tax deductible. Another reason why mortgages, student loans and even home-equity lines of credit are classified as good debt is because they’re tax deductible, while credit card debt and auto loans are not, points out Rob Seltzer, a CPA in Beverly Hills. The only way you can deduct some of the costs associated with your car are if you use it for work.
If you have to have debt and the interest that goes along with it, it’s nice if it at least gives you a little back!
It can fill gaps in cash flow. If you are an entrepreneur or are in a profession where a huge chunk of your income is your end-of-year bonus, you can justify a home-equity line of credit or small business loan.
Short-term loans like these "can ease you through that time period because cash flow is uneven,” Francis said. “But it goes back to: Are you paying it off when the money does come in? Are you able to save? Make sure you can do that,” she advised.
The important thing is to not have the debt — or the interest rate — be so great that it’s putting you financially behind.
It can help you reap rewards. Have you ever seen those ads on TV that if you buy this car, you’ll get a zero percent interest rate for five years?
“That’s not for everyone — that’s for people with good credit,” Seltzer said. “And it can save you thousands on the life of the car loan.”
“It’s basically letting you use somebody else’s money for a period of time,” explains McBride.
Why would you spend $30,000 of your own money, when you could take out that loan at zero percent, and keep the $30,000 you would’ve spent on that car in a CD or other investment? You borrow the money for free and keep your money working for you. The trick, of course, is paying it off before the zero percent expires.
And, while credit-card debt is usually classified as the bad kind of debt, one exception is rewards points. If you use your credit cards responsibly and pay off the debt in a timely manner, you can redeem your points for everything from dinners and gift certificates to plane tickets. That’s money in the bank.
Seltzer said he not only uses a credit card for everyday expenses, he even put a $3,000 down payment on a car on his credit card to boost his miles.
The key is to use debt wisely — Don’t get yourself in over your head and pay your bills on time. If you do something like put a $3,000 down payment on your card, make sure you pay it off right away.
And remember that debt is like a chainsaw: Rev it up when you need to tackle something big, but handle it carefully.
More on Jobs and Money:
- In Search of the Perfect Credit Score
- Money Resolutions for 2011
- 10 Apps to Help You Keep Your Resolutions
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