Is it possible to turn debt into profit?

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The term “debt” has long been associated with a negative meaning. When excessive and left unmanaged, this financial obligation can put additional strain on one’s finances and budget. That’s why it’s often avoided or used as a last resort by many at all costs.  However, contrary to this belief, debt is a powerful financial tool to build long-term, steady wealth.

To understand this, one should first understand the difference between “good” and “bad” debt.

What is a “Good Debt?”

Good debt is any borrowed money used to purchase items or services that can increase in value over time or provide other financial benefits. It can be taken out from traditional financial institutions or alternative lenders like CreditNinja.com as long as it helps one reach their financial goals, such as increasing financial security, building wealth, and becoming more successful.

Examples of good debt are:

  1. Mortgages. Mortgage payments can help build equity (i.e., the value of a property after liabilities are subtracted), which could result in a higher net worth. Additionally, interest paid on them can have potential tax advantages.
  2. Student loans. Financing education to earn a degree is one of the stepping stones to earning higher earnings in the future. This is because many companies require a degree for a job position or promotion.

Another advantage of student loans is that they’re more affordable than other lines of credit as long as they’re managed well. Compared to other lines of credit, they have lower interest rates. Plus, like mortgages, their interests can be tax-deductible.

  1. Personal loans. When used appropriately, personal loans can also be considered good debt. For example, if the funds are used to consolidate debt, then it’s considered beneficial

To make debt “good,” one should use it responsibly. Individuals should be mindful of the debt’s amount, terms, and interest to do so. As much as possible, only take on debt that’s manageable based on one’s current financial situation and income. Doing so will not only help them achieve their financial goals but also build better credit and access new financial opportunities.

What’s “Bad Debt”?

Bad debt is any debt that’s hard to pay off and doesn’t have long-term benefits. It’s often used to categorize non-performing loans (NPLs), which are loans in default because the borrower didn’t pay for more than six months, and uncollectible loans, which are loans that borrowers are unlikely to pay due to several reasons, like bankruptcy.

Examples of bad debt are:

  1. Credit card debt. It’s one of the common examples of bad debt due to its high-interest rates. As of February 2024, the median interest rate for over 300 credit cards is at 24.37%.
  2. Car loans. Although cars are a necessity for many, financing them is considered bad credit by many experts. This is because, unlike real estate properties, cars depreciate in value. They’re also considered ongoing living expenses. Supporting them with debt means one will likely have long-term financial obligations, which, again, don’t increase in value.

Bad credit has several consequences. For individuals, it primarily reduces one’s credit. This could lead to trouble getting other forms of financing, fewer renting options, higher insurance costs, paying deposits for utilities, and fewer job opportunities. All of these can result in increased stress and anxiety, which can harm an individual’s health and well-being.

For companies, bad credit also affects their creditworthiness. It doesn’t only lead to lending difficulties but also inventory, supply, and utility problems since many providers check and assess companies’ credit nowadays.

So is debt profitable?

If it’s good debt, it’s potentially profitable. One of the strategies to turn debt into profit is through leveraged investing, where borrowers seek higher investment profits by using borrowed money.

For example, let’s say Anna invests $100 with an expected 10% return on investment (ROI). If she invested her own money, she would earn $10. But if she invests half her money and borrows for the other half, she could earn more if the loan interest is below 10%. In this case, she leveraged her return.

Another way is borrowing funds to diversify investment portfolios. This is particularly beneficial to shareholders with a big portion of their investment portfolio in a single stock. They can have a more balanced long-term investment by borrowing against that concentrated position to buy other companies’ stocks. Plus, if they sell the concentrated stock, they can defer paying the capital gains taxes.

Other ways to leverage debt are:

  1. Margin Investing
  2. Leveraged exchange-traded funds (ETFs)
  3. Hedge Funds
  4. Short Selling
  5. Forex Trading

These strategies have extraordinary profit potential. However, they’re complex, especially for beginners and those who are less knowledgeable. They can work against you, potentially wiping out your entire investment in as fast as a few seconds. Hence, it’s highly recommended to do due diligence before taking these investment strategies and seek professional guidance, if possible.

Final thoughts

While debt is typically seen as a negative measure, it can also be a positive financial method. It doesn’t only help one to meet financial goals but also access investment opportunities that may exponentially multiply ROI. The key to achieving these is to use debt appropriately and responsibly.

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