WTFinance is leveraging debt?
Ever heard the saying that it takes money to make money? In other words, you have to put something in to get something back. That's kind of how leveraging debt works.
In a nutshell, you borrow money, invest it, and hope to profit. If your investment pays off, you walk away better off than when you started.
You don't have to be an investor who plays the market daily to leverage debt. In fact, you might be leveraging debt without even realizing it.
What does debt leveraging look like?
There are different ways to leverage debt, but the end goal is more or less the same: to make money.
Here are some examples of debt leveraging in action.
You take out a $150,000 loan to buy and fix up a run-down home. Eight months later, you sell the home for $350,000.
You buy a 4-unit property. The mortgage payment is $5,000 per month. The units rent for a total of $6,400 per month, which covers your monthly payment and a contribution to a savings account for future maintenance.
You’ve been in your home for a long time, and you’re ready to sell. You want top dollar, so you take out a small home equity line of credit to upgrade your lighting and replace the garage door. Those renovation projects increase the sale price by more than the amount you borrowed.
You want to pay off your high-interest credit cards, so you borrow money. It seems counterintuitive to borrow to get rid of debt, but if you’re able to simplify your finances and potentially lower your interest rate, you could use the new loan to reach your goal.
You’ve leveraged debt to put yourself in a better financial situation.
Some people might even consider student loans to be leveraged debt. You borrow to pay for school in the hopes that you'll be able to earn significantly more money once you start your career.
When leveraging debt can be risky
Leveraging debt has a built-in risk factor since you're borrowing money. The hope is that you’ll make money, but you’ll still owe the debt even if you don’t.
Where you can run into trouble with leveraging debt is if you're doing things where there's a high chance of financial loss. For example, say you want to buy some stocks but you don't have any cash. So you get a personal loan and use it to buy the shares.
Things are looking good, and the stock's price is going up until…a market crash sends it spiraling down. Now your investment is worth less than what you owe on the loan, which you've still got to pay back.
If the stocks recover and prices shoot back up, the dip might become a distant memory. But if not, you've leveraged yourself into a potentially bad situation if you can't keep up with the debt payments.
What to consider before taking on debt
Any time you're thinking about borrowing money, ask these questions:
What is this money going to help me do?
How much is it going to cost in interest and fees to borrow?
Can I realistically afford the monthly payments?
What's the worst-case scenario if the asset loses value or becomes worthless?
What happens if I can’t pay?
If you find yourself in a situation where you've leveraged debt with good intentions but you're struggling to pay it off, you've got some options. Get a free debt evaluation. A professional debt consultant can help you come up with a solution for managing your debt with less stress.
