How To Use Debt To Create Passive Income

So, debt is bad. Right? In most situations, parents, mentors, and other influential figures have attempted to convince us of this “fact”. For one reason or another, most have grown up with the inclination that all debt is bad, and you should avoid it at all costs. If you have listened to Dave Ramsey or Suzie Orman, they have definitely reinforced this opinion in the minds of their audiences.

But, are they really correct?

Not to say there is anything wrong with feeling as if you need to pay cash for everything, because this is not a bad choice at all. Low-interest debt that helps you increase your income or net worth are examples of good debt. But too much of any kind of debt, no matter the opportunity it might create, can turn it into bad debt.

There are simply other options that you may want to explore that can allow you to exploit the benefits of debt for personal gain. In this article, I will outline some of the ways that you can make this possible for your personal or business finances.

Personal Debt

Personal debt has historically been one of the things that my mentors and various others have told me to stay away from. Which, in the context of credit cards, can 100% be true. The consumerism that drives the United States can constantly make this a difficult plague to steer clear of, but it is important to be vigilant and only purchase things you can afford.

That said, there are plenty of ways that you can utilize personal debt to actually create personal gains. If someone told you that you could pay 20% on a $100k loan, and you would make a 100% return on that loan, I challenge any of you to say that you would not take that!

These are the situations that you are looking for, that can offer a substantial benefit for your personal finances over a short period of time.

Example:

Let’s play out another scenario. If you were to use debt to purchase a house in an upcoming area of town, for well below the projected market value, then who could call you foolish for that? This is one of the more powerful ways to use debt to your advantage. If you look at most of the absurdly wealthy people on earth, many of them have made their fortunes, or at least some part of it, using this strategy.

By utilizing the value of the things or properties you already own and borrowing off of the value of those properties, you can parlay that money into purchasing more and more properties that you can either rent or sell for a profit. If you were to purchase a house/building for $100k on a 5% loan for 30 years, your mortgage would be somewhere around $300/month. If you were to then turn around and charge a tenant $600/month to live there, you would theoretically be able to pay off your mortgage in half the time, then continue to gain income from this house over time.

Debt isn’t necessarily the worst thing after all.

Investing in a business is another great way to use your personal gains to multiply a few times over. When I was growing up, my father was never the kind of person that liked working for anyone. He always had his own business, whether that was a logging company, a car lot, or a plumbing company. Initially, he was starting these businesses from nothing, with little loan money. In time, he realized how to use debt to his advantage. He purchased the plumbing business for just south of one million dollars and began to grow the business.

When he first purchased it, the profits were around $70k. While this is not a bad number, he knew if the business grew, he could pay back the loan quicker. Therefore, he’d be able to reinvest that money into more profitable ventures. Within 5 years the profits had increased to $250k/year, and he is now nearing the payoff point. In the meantime, he has periodically used profits to purchase multiple rental properties, more assets for the business, and a few houses for the different seasons of the year. Now, that is how to use debt to your advantage.

College Debt

Yes, this is about student loans. Student loans are the second largest form of debt in the United States behind mortgages. Student loans never used to be an issue of this magnitude. Typically, people would either pay for college or just not go. This changed in the 1970s and continued to spiral out of control until now we have reached over a trillion dollars in collective student loan debt. But, what does this mean for you?

If you have student loan debt, you are in the majority. Depending on your situation, the question is, is/was it worth it? If you are in high school, and you are in between going to a state school, or a highly ranked university (just because you have friends going there), you may want to consider that decision carefully. The difference in the curriculum doesn’t typically correspond with the difference in dollars spent. This is where a cost-benefit analysis (or just a simple pro and con list) will come in handy. For the $100+k a year that you will spend going to a top university, you could fund two state school educations where the overall benefit is really the same.

However, if you are an adult that is out of school with this loan debt that you have no idea what to do, you may want to try a couple of different things. One of which might be loan consolidation. If you go to sofi.com, you will be given a couple of different options for loan consolidation, and in most cases refinancing. This will allow you to take those 9% interest rates you are currently paying, and turn them into something more reasonable like a 3% rate. This opens the door to more of the investing strategies that I outlined above because you are not spending all of your extra money on loan repayments that aren’t gaining you any value. Sure, a degree in some situations can be beneficial. But, your money can be spent in much more profitable ways than getting your undergrad in general studies, then complaining that you can’t find a job.

Business Debt

Utilizing debt in businesses is similar to personal uses for debt. If you are responsible, debt can be used to drive your business. Like him or not, Donald Trump used debt to build his business empire in the 1980s. It caught up to him when he was using that debt to purchase yachts, planes, etc. instead of using solely his profits for those purposes, but that is what I am going to try to get you to avoid.

One of the most common ways to utilize debt in a business situation is on new product investments. Until you are the size of some of the large pharmaceutical companies that spend most of their income on reinvesting towards research and development, you will need to operate off of debt.

debt new investment

Whether you have come up with a catchy phrase to put on a t-shirt, or you are an engineer that has created the next great gadget, getting funding can be one of the most difficult things about starting a new business. However, if you have a good product or service, it can be easier than you would think to get some investors that believe in your product. While this is not debt for your business, if you get the money from investors, it can hinder you in the long run if you give up too much of your business too soon.

The perspective of the investor could be viewed as purchasing a stake in the company that you believe will yield a long-term gain. Think of the angel investing rounds of Uber, or Facebook. While these companies had no money at the time, if you invested $50k in either of these giants in the initial investing rounds, it’s safe to say you would not be reading this article.

New products, however, are the driving force to all consumer-based businesses. Take the fidget spinner for example. In 2018 they exploded, and countless people from children to executives were carrying them around, as a way to get some sort of dexterity satisfaction at all hours of the day. The issue came in when there was nowhere else for the product to go. Sure, some of them got branded with team, or school logos, but after that, they fizzled out into the nothingness of the dollar bin at Wal-Mart.

In order to grow your business, you will need to be able to invest in new product solutions for your consumers. This costs money! In the early stages, it can be intimidating to go to a bank and request a loan for money that you aren’t entirely sure you will be able to pay back. This is why you must be strategical in your borrowing, and do it in stages. Just because the bank approves you to borrow $50,000, does not mean that you must take out the entire amount. Take the $10,000 you need to get your prototypes together, (or however much you NEED) then explore more options for angel investing down the line. If that $10,000 loan affords you the opportunity to make $100,000 in the next year, I seriously doubt that you will regret using debt to your advantage.

In summary, what can debt do for you?

When used correctly, debt isn’t a bad thing. If you are utilizing it responsibly, then it can lead you to financial freedom. This isn’t to say that debt has not harmed people in the past, but most of those people were spending on things that were not wealth generating assets. That is the difference. Jim Rohn once said, “Wealthy people spend money on income generating assets, while the rest of the world buys new cars”. While there is nothing wrong with buying a new car, if you can afford it, this is a problem that plagues most of America. We’re told by advertising, peers, and movies that you should want the expensive things in life, and you should use debt to purchase them. That’s not entirely true. You should use debt to create profit for yourself, then, use that profit to purchase all the new cars you want!

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