U.S. citizens have $15 trillion in household debt. Within this astronomical number, there are both good and bad loans. When people borrow and spend the money on something that won’t appreciate in value (often with no other choice), they’ve taken on bad debt. But when it’s used to invest in something that appreciates more than its borrowing costs, debt can be a good thing.
Businesses use debt all the time. Apple (NASDAQ: AAPL) has over $100 billion in debt, which it reinvests in new products and generate profits. With good credit, you can utilize good debt for yourself, too, the same way a business does. You simply need a secured loan with predictable and manageable cash flows. By borrowing at a low rate (3%) and getting a higher rate on your investments (8%), you can earn an additional 5% on your money. Borrowing to invest can enable you to earn more money, without needing a higher paycheck.
We are living in a unique environment with increasing inflation, even as borrowing rates remain near historic lows. People can get mortgages for under 3%, and lock in those rates for over 10 years! By using stable assets as collateral, such as your home or stock portfolio, you can often get a loan at an attractive rate and invest the proceeds for a healthy return. Before taking a loan as part of your investing strategy, just remember a few key ground rules.
1. Evaluate your debt based on monthly cash flows.
You never want your debt payments to go over 36% of your income. Beyond that inflection point, banks have decided that borrowers start becoming unreliable about making payments, and banks use that figure to decide whether to give people loans. For an average family earning $5,500 per month, that 36% threshold limits their debt payments to $2,000 — a sum that encompasses mortgages, auto loans, credit card interest, etc.
If you are spending more than 36% on debt-specific payments, then you shouldn’t use debt for investments. Instead, continue to pay off your existing debt until you’re far enough on the other side of your inflection point to safely take on more.
2. Find a low rate opportunity
With all their accompanying jargon and promotional rates, loans can be very confusing. Here’s what to look for.
For long-term loans of five-plus years, you should look for fixed rates, because they are transparent and predictable. Anything under 4% is a good rate, since you can expect to earn twice that in the long run from the stock market. The lower your rate, the better. Because of compound interest, rate is the most important factor — the lower the rate you’re charged, the more of your gains you can keep …….