Why debt can make the rich richer

“Debt is a dirty word. Try and stay away from it as much as possible”. Ever heard this before? Well, you’re not alone. Yet contrary to common theory, debt isn’t always a bad thing. In fact debt can indeed mean development. You've just got to change your mindset about why you use it, so the ‘how’ to use it right becomes simpler.

The importance of financial literacy

In case you’re reading this and wondering why you’re not more across the ‘how-to’ of debt, let me assure you, this is not a case of you - it’s ‘us’. And when I say ‘us’, I mean Australians.

The basics of financial literacy aren’t taught in schools, and yet money makes the world go round. As a nation, our basic financial literacy is actually relatively low. According to a study conducted by the Melbourne Institute of Applied Economic and Social Research’s Household, Income and Labour Dynamics in Australia (HILDA) survey, less than 50 per cent of surveyed Australians could answer all five basic financial questions presented to them correctly.

In my time as a financial adviser, I saw countless clients who had racked up $20,000, $30,000 and even over $100,000 in combined credit card debt across multiple accounts. Our lack of education on money is stalling our progress, and if you’re not careful, you too could rack up debt that will begin to drain your money unnecessarily.

What is the difference between “smart debt” and “ordinary” debt?

Despite some horror stories you may hear, debt is essential to growth.

How?

Because by using debt, you’re unlocking the ability to bring your future forward - to create something from nothing.

Want to buy a house but don’t have all the money you need? Debt can help you make that purchase happen.

Want to invest in education but don’t have the thousands set aside? Again, debt can be your answer. While this may sound controversial, it’s the mindset of the wealthy, and governments alike, who use debt as fuel to fund growth.

The mindset shift you need to make is this: debt is an essential ingredient to wealth, when used in the right way. When you borrow money to purchase an asset, such as a property, you’re able to benefit from that asset right away and also experience the value uplift of that asset, in exchange for a premium (the interest you pay on the loan).

The smart way to make money by using debt is to ensure that the value of your asset is making more than the premium you are paying for it. A more assured way of doing this is to have the asset provide you with income as well as capital growth, such as rent or dividends, ensuring you can meet your ‘debt premium’, (interest repayments), and still have money to cover the capital.

A great example of smart debt is education. Taking out a loan for a degree or specialised education puts you into a substantial amount of debt but as it has the potential to raise your future income while benefiting from a low interest rate compared to other loans you can turn that ordinary debt into smart debt.

Having a degree gives you an edge in a highly competitive job market, giving you the potential to raise your future income while benefiting from a low interest rate compared to other types of debt.

In contrast, ordinary debt such as taking out debt on credit cards for holidays or purchases can turn ugly real fast. It’ll give you a high like a good cup of coffee but with an unfortunate crash of having to pay the money back - with an interest bill attached.

Do your research

Aside from understanding the difference between smart and ordinary debt, it’s also important to educate yourself and do your own research.

For example, when applying for a mortgage, the bank will lay out your recommended repayment plan, which will often have you paying back the loan with affordable monthly repayments over a period as long as 30 years.

If you do exactly what the bank tells you without digging into the facts, you may end up paying as much as the loan itself in interest. But did you know that paying off your loan fortnightly as opposed to monthly can save you thousands in interest repayments? And did you know that negotiating and refinancing your loan regularly will help you keep costs down as well?

Always do the research, know the facts, work out what you can afford and how that will affect the amount of interest you will need to repay yourself - it literally pays to do so.

Using debt for development

Debt (when used correctly) can be a powerful tool for your personal, financial and professional development. If you build and call on your financial literacy and financial intelligence, you can start to see how you can use debt to your advantage and create smart debt that works for you.

Here is an example how to do it:

Taking out a loan for an investment property will incur substantial debt. However, it also comes with a multitude of benefits including; tax efficiencies, income earned on the property that will assist you with repayments as well as the benefits of negative gearing.

Taking out a loan on an investment property won’t tie down a huge amount of your income, in fact, it will actually allow you to diversify your income. Because it’s mostly unencumbered, you can use the money to invest in other things simultaneously (such as in shares) without having to wait 30 years to do so. You’ll end up with two different wealth baskets being created for you simultaneously rather than one after the other.

You also have the opportunity to fast track the repayment of your debt by adding your rental income and making additional repayments to the loan. Doing so can have a major impact on the lifetime of your mortgage and the interest you save.

For example, say you take out a $400,00 loan over a 30-year period and pay it back at a range of $2,039 per month. Over the lifetime of the loan, you will spend $733,912 in total loan repayments and be charged $333,912 in interest.

However, let’s say you change this to fortnightly repayments and add an additional $700 per fortnight from your rental income. Over the lifetime of the loan, you will now be spending $521,946 in total loan repayments and be charged $121,946 in interest. That’s almost a quarter of a million dollars less!

So the next time someone advises you to stay away from debt, open up the conversation about accessing smart debt. You’ll likely be enriching someone else’s mind while you work towards your future wealth.

For any women who want to continue to grow their financial literacy, along with their leadership skills, career, self-awareness and more, then get yourself onto the waitlist to join The Remarkable Woman’s Signature Membership!

Shivani Gopal is the Founder and CEO of The Remarkable Woman; a women’s mentoring and leadership platform.

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