Debt As a Tool

When people talk about their plans to achieve financial independence, eliminating debt is inevitably one of the items on their to-do list. It makes complete sense when you think about it. Being financially independent means that you can cover your expenses without having to rely on income from working. Annihilating your debt is one way to reduce your expenses and move closer to financial independence.

Dave Ramsey, a well-respected personal finance author, even provides several different approaches to paying down debt so you can choose the one that works best for you. In most cases, I absolutely agree that eliminating debt is great! However, with so much negativity surrounding the topic, it’s important to point out that debt can be a powerful tool.

Benefits of Debt

Too often, debt is viewed as poison in the world of personal finance. However, people seem to forget just how useful it can be when used responsibly. Think how difficult it would be to purchase a house if debt didn’t exist. If you think saving up a 20% down payment is a struggle, imagine trying to save enough cash to purchase a house outright! For many, that would be a nearly impossible task.


Our house, purchased with debt
Without utilizing debt, Nicole and I wouldn’t have been able to purchase our house.

Without some form of auto financing, some of us might be stuck riding a bicycle to work every day. If student loans weren’t an option, many people wouldn’t have the opportunity to attend college, drastically reducing their earning potential and making employability more difficult.

Me with my 2003 Buick
Without debt, I have a feeling there would be more people driving cars like my 2003 Buick Regal. Not ideal.

How We Use Debt

Personally, I’m a big proponent of debt. When used appropriately, leverage can be a powerful tool. Debt has played a role in allowing Nicole (my wife) and me to afford our first investment property. It has provided flexibility to help me start my moving company. We even use debt in the form of margin in our investment account to leverage our existing capital and create opportunities for additional returns.

WARNING: Using margin increases the amount of risk you assume. DO NOT use margin if you do not fully understand all the risks.

Even though Nicole and I are striving for financial independence, becoming debt-free isn’t near the top of our to-do list. In many cases, we have decided to take on debt for investment/business opportunities. When doing so, our goal is to generate a return large enough to cover the interest payments and to provide additional income in the process.

For example, we recently completed a cash-out refinance on our investment property. We refinanced the property at a rate of 4.125%. As the name implies, the refinancing process provided us with some cash, which was determined by the equity that we had previously accumulated in the property. Since we feel confident that we can achieve an average annual investment return in excess of 4.125%, we don’t put any additional money toward the mortgage principal. Sure, if we did, it would guarantee that we would pay less in interest over the term of the mortgage. Instead, we believe we can use the money elsewhere to receive a greater return.

We practice the same technique with the mortgage on our primary residence. Since our private mortgage insurance (PMI) has been removed, we haven’t made any additional payments to reduce the principal amount of the loan. Again, we invest the money elsewhere with the intent of earning a return greater than our mortgage interest rate.

Avoid the Pitfalls

Let me be clear, there are certainly less than optimal and irresponsible uses of debt. Using a credit card to purchase a pair of expensive designer shoes you cannot easily pay off is most likely a poor judgement call. That balance will sit on your credit card statement and accumulate interest month after month. When accounting for interest, those soles will end up costing you a piece of your soul.

Additionally, it’s probably not ideal to take out a second mortgage on your home in order to afford an extravagant tropical vacation. Even though that poolside service might be luxurious, the debt that comes with the vacation will follow you long after your suntan has faded.

Don’t Be Afraid

The point I’m trying to get across here, is that you shouldn’t be afraid of debt. Most people aren’t born debt-laden. In many of the horror stories you’ll hear, poor judgement led to financial ruin, not the debt itself. Deciding whether to take on debt should be calculated. Ask yourself some of the following questions before taking out a loan. It could save you from making a commitment you’ll later regret.

Will the monthly payments that come with this debt impact my ability to reach the goals I have set? If yes, am I okay with that?

Can I realistically afford to make the monthly payments with my current income level? If not, seriously reconsider your decision.

Is this debt for investment/business purposes? If yes, will it ultimately improve my financial picture?

When our society paints debt in such a negative light, it can be hard to see the positives. If you have any questions or if you would like me to further explain my rationale, please leave a comment below or send me an email.

Your thoughts are worth more than a penny.

This Post Has 22 Comments

  1. Aaron Helander

    I am also a big proponent of using debt as leverage. When debt helps you to make more money, it is smart. I am not a fan of consumer debt or living outside of your means. That is bad debt. Great article!

    1. Nicole Nicholl

      Aaron, I totally agree! Before Noah came into my life I was headed down the path of spending above my means.. the worst part is, I didn’t even realize that was the case because I never sat down to actually make a budget outlining my spending vs earnings.

    2. Noah 5¢

      I’m with you Aaron! Using debt wisely can provide great benefits, but living a lifestyle you can’t actually afford is a recipe for disaster. Thanks for reading!

  2. Kenneth Nicholl

    Debt that works for you is a great concept….sadly, too many people cannot differentiate and subscribe to the “I want it now” philosophy and take on more than they can afford. It is like anything,…..there has to be a balance.

    1. Noah 5¢

      I agree. I fear that some people make impulsive decisions when using debt and don’t consider all the consequences.

  3. Nicole Nicholl

    I had a professor my senior year of college tell us on our last day of class, that if we remember nothing from her lectures all year, remember this “Always live below your means and you’ll never struggle financially a day in your life” mind you I got my degree in Kinesiology and the class she taught was childhood development, yet this one sentence still stuck in my mind… she said time and time again she sees college students enter the “real world” get their first “big adult job” and salary for that matter and start spending above and beyond what they can afford. While it’s important to treat yourself for your hard work and effort, I think that if you always live and spend just a little below what you can actually afford you will never stretch yourself too thin financially! (Bonus: you can start to invest the extra money you save and grow that sum without even thinking about it!)

    1. Kris Gustke

      It seems like most of us know someone (or were that “someone”) who uses or used to use credit in a way that is/was very detrimental! It is very easy to fall into the habit of spending money that you don’t really have and getting deeper into debt. I never really thought about “benefits of debt” or “using debt as a tool” until I read this. Also, I have a question regarding margins, what are they?

      1. Noah 5¢

        I agree. When you simply swipe a card and don’t feel your wallet become any thinner you can easily get in over your head. Well I’m glad that I was able to provide a new perspective!

        Before I get into an explanation of margin, please note that using margin increases the amount of risk you assume. Do not use margin if you do not fully undertand all the risks.

        A margin account is a type of investment account that allows you to borrow money from your broker (Ally Invest, Charles Schwab, TD Ameritrade, Robinhood, etc.) based on the value of the securities (stocks, bonds, and other investments) that you hold in that account. Using margin allows you to leverage your money by providing you with more purchasing power than you would have otherwise. Your broker will charge you interest based on the amount of your margin loan. In our case, we pay interest monthly directly from our investment account.

        Margin also acts as a “double-edged sword.” If you purchase an investment using margin, and the value of that investment decreases, your loss would be amplified. On the other hand, if you purchase an investment using margin, and the value of that investment increases, your gain would be amplified.

        For example, let’s say you deposit $5 into your margin account (I’m using small numbers for simplicity. In reality, there are typically specific minimum requirements that need to be met). Following the deposit, you purchase one share of XYZ stock for $10. To do so, let’s assume you use $5 of your own money and a $5 margin loan. If the price of XYZ stock decreases to $5 and you decide to sell (or are forced to sell if your broker makes a margin call), you would lose all your money. You would sell the share of XYZ for $5, use the proceeds from that sale to repay your $5 margin loan (plus interest), and be left with nothing. However, if the price of XYZ stock increases to $15 and you decide to sell, you would double your initial investment. You would sell the share of XYZ for $15, use the proceeds from that sale to repay your $5 margin loan (plus interest), and you would pocket the remaining $10.

        As the above example shows, a 50% change in the price of XYZ resulted in a 100% loss/gain, hence the “double-edged sword” comment.

        Additionally, because I trade option contracts (a topic for another time), using margin provides me with greater flexibility.

        Thanks for the question!

    2. Noah 5¢

      In my opinion, that was one smart professor! Going from “broke college student” to young professional can be a difficult transition to navigate. Up until that point, most people haven’t experienced a full-time income so turning into the proverbial kid in a candy shop isn’t too much of a surprise. There are a lot of pent up desires and it can be difficult to keep your spending in check. Finding a responsible way to reward yourself for your hard work is important. However, spending more than you earn is ultimately a roadmap to nowhere. Living below your means is very important and, like you said, it allows you to start investing!
      Thanks for reading!

  4. Kara Shuell

    I like your views on the use of debt as a tool to leverage more financial freedom.

    1. Noah 5¢

      Thanks for reading!

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