Turning a negative into a positive is the holy grail of perspective, right? Who wouldn’t want to take all of the bad things in the world, and make them fit into a nice box, tied with a pretty bow. While that may be wishful thinking for some topics, it may present opportunity for others.
Let’s take debt, for example. We’ve all heard at some point or another that debt is bad. What if that wasn’t necessarily true?
My husband and I have been binge watching a certain show on Netflix. It’s about a company that’s just getting started. They’re looking for funding in order to bring their product to market. There’s all sorts of drama and mayhem that the characters get into just to get their company going. The thing that stands out to me is the fact that they’re risking everything in order to borrow money. In essence, they’re willingly and voluntarily trying to get into debt. To them, getting into this type of debt is worth risking everything. Yes this is a show, there’s a storyline, everything is scripted, the characters are fictitious, so on and so forth. Nonetheless, the storyline is based on a real concept. It’s based on the concept of using debt as a business strategy. Watching this show makes me think about how we, as regular people view debt and how it impacts our lives.
With that in mind, it raises the question as to whether debt can be used in a positive way. When I think about debt, there’s a spectrum that I envision. On one side, there are those who are completely debt free. On the other side, there are those who are completely buried in debt. Then, there are those who are somewhere in the middle.
Types of Debt
Not all debt is created equal. In fact, there are several types that we could consider. Let’s focus on some of the most common categories: Secured debt, Unsecured debt, Revolving Debt, and Mortgages.
Secured debt, is where a lender allows a person to have access to money, while they hold onto something of value. That thing of value is called collateral. The lender does this to ensure that the person to whom they lent the money, actually pays it back. An example of this is a car note. In this example, the lender loans money to the borrower, so that the borrower can purchase a vehicle that day, and pay the money back over time. During the time that the borrower has to pay the money back, the lender is able to take the car if the borrower fails to make payments according to the agreed upon terms.
Unsecured debt is where a lender allows a person to have access to money without holding any type of collateral. Based upon the borrower’s creditworthiness, the lender trusts this person to pay the money back based solely on their signature. The borrower signs an agreement, promising to pay the money back, and the lender trusts them to do so. An example of this is a student loan.
Revolving debt is very similar to the unsecured debt. The difference is that the borrower is allowed access to money on a recurring basis. With typical unsecured debt, the person borrows the money, pays it back according to the terms, and the agreement complete. With revolving debt, once it’s paid off, funds are available to be used again. An example of this is a credit card. The credit card company allows the borrower access to a certain amount of funds. The borrower is able to use those funds how they choose, up to a certain limit, and then the pay it back. They can continue to borrow and repay for as long as the account is open.
A mortgage is a type of secure debt. The difference is that this type of debt can only be used to purchase property. With a mortgage, a lender allows a person to borrow money to buy a property. That lender holds the right to that property until the mortgage is paid off. This simply means that the property is collateral for the loan.
Now that we’ve covered some common types of debt, let’s talk a little about our perception when it comes to debt. What’s the first thought that comes to mind when you hear the word debt? It might be owing a lot of money. It could be collectors calling and harassing you. It could be stress. Perhaps, it could be high interest rates. The list could go on and on. There’s a negative connotation associated with debt. It’s likely because so many people have had negative experiences with debt. Think about a hot stove for example. If you’ve been burned in the past, that experience stores in your subconscious. Now when you think about something being hot, you subconsciously associate it with pain. The same thing happens if we’ve had a bad experience with debt.
Say, for instance, a person is at the mall. Let’s call her Alexis. She’s at the mall to buy a couple outfits to wear on vacation. She does her shopping and gets to the register, where the sales person mentions a promotion that will allow 20% off of the purchase if she opens a credit account. Keep in mind that store credit accounts are a type of revolving debt (aka store credit card). In this example, Alexis can buy what she wants today, get 20% off, and pay the rest later. With the 20% discount, Alexis sees this as an opportunity to save some money, which sounds good. Right? She applies and gets approved for $1,000 credit limit. Also, since she’s able to pay later, the money that she’d originally planned to spend, can now go toward her trip. On top of it all, the 20% discount is only good for today. So if she wants to get the most out of this discount, she needs to buy as much as possible today. By the time that she leaves the store, she’s used the entire $1,000 credit limit, chasing after the 20% discount. The card is maxed out. Once interest is factored in, the account is over the limit. She never planned to spend that much, so she certainly didn’t have a plan for the payments. Since the payments weren’t factored into her monthly expenses, they’re not being made, and the account goes into default. The account is now reporting negatively on her credit. If Alexis starts making the minimum payments, the balance will not decrease much, because the majority of the payment goes toward interest. Interest continues to grow, creating a cycle.
After Alexis somehow gets herself out of this cycle, and if I were to ask her the same question that I previously asked concerning the first thing that she thinks about concerning debt. Her experience that started at the mall will most definitely influence her response. While this may be true for a lot of people, there are others who may respond differently. Some believe that there’s absolutely no good that can come from any type of debt, while others may disagree.
How to Make Debt Work For You
Let’s now look at some examples that are opposite this situation, where debt can actually work FOR you.
Think about a person who has a business idea. Let’s call her Tasha. Tasha has an idea, and she knows, without any doubt that there’s a need for what she has to offer. She has the drive, the work ethic, and the skills needed to make it happen. The problem, is that she’s short on cash. Tasha’s resources are dedicated to making ends meet. In order launch the business, Tasha needs $10k. Her business idea has the potential to bring in in $100k per year. Tasha knows this because she’s done the research. The solution to Tasha’s dilemma is to take out a business loan. Let’s say for example sake that it takes 6 months to get the business up and running. As the business begins bringing in revenue, the first thing that Tasha does is pay off the loan. This outcome is drastically different from Alexis and her day at the mall.
Think about a college student. Let’s call her Crystal. Crystal’s done well for herself. She’s laser focused on her goals and what she wants to do professionally. She’s researched her field, and knows that there’s a high demand for what’s she’s studying. And not only that, entry level job prospects are pretty good as well. Her grades are good, so she has a scholarship that covers most educational expenses. The problem is that she’s short a couple thousand on tuition. Based upon her skills, her earning potential without this degree is pretty low. So Crystal decides to take out a student loan. The lender offers $10k, but she only needs $2k to complete the program. Thinking responsibly, Crystal only borrows what she needs. After graduation, Crystal gets an entry level position in her field, and continues working part-time in order to double up on student loan payment. Her goal is to pay the loan off before the interest begins to accrue. In a year, the loan is paid off.
Think of the fledgling real estate investor. Let’s call him Jevon. Jevon has an opportunity to buy a condo for $100k in a popular tourist location by the beach. Because of the location and incredibly low price, there’s a lot of interest in the property. He has enough money saved to be able to buy the property with cash, but not quite enough to make renovations. The property will require at least $20k in renovations. He decides to take out a mortgage to buy the property, and use some of his savings to renovate. After the renovations are done, the property is worth $300k. Jevon sells the property, and pays off the mortgage.
Three Steps to Optimize Debt
There are a few things that these examples have in common. One of the main similarities is the concept of leverage. By definition, leverage, when used as a verb means to use something to maximum advantage. In each of these scenarios, the person used debt to its maximum advantage to accomplish a goal. Why are these scenarios different from the first one that I shared? It comes down to 3 things that are required to turn debt from a negative to a positive.
Strategy means that you have a plan. You’ve weighed the costs and benefits. You’ve allowed for the contingencies. You have a clear purpose and a goal. Not only that, you’ve outlined step by step how to get from point A to B.
Management simply means that you’re staying on task. You’re following the plan that was created when you outlined your strategy. You’re not borrowing more than you need. You’re making payments on time. You’re keeping track of where you are from the time that you receive the funds to the time that they’re paid back in full.
Discipline is what it takes to effectively manage debt. It helps you to avoid the impulse to borrow more than you need, or to spend the money on something unrelated. It also helps to ensure that you pay the money back when the funds available to you.
Keep in mind that my goal is not to encourage anyone to go out and get into a bunch of unnecessary debt. My goal is to share a different perspective and illustrate that when used wisely, with strategy, management, and discipline, something that could be a tool of bondage, can actually be used for your benefit.
Also, I want to offer encouragement to those who may be struggling with debt. Maybe you started out with good intentions. However, somewhere along the lines, things went off the rails, leaving you with a ton of debt that you don’t know what to do with. Let me be the first to tell you, that there’s hope. With strategy, management, and discipline, you can get out from under that burden.