Welcome, Future Early Retirees.

A lot people will tell you "debt is bad,” but don’t bother to explain why. While it is true that debt can be ruin you financially, it can also be the fuel that propels you to financial success. I want to dig deep to explain my thought process on how I think about debt.

In today’s newsletter:

• Good debt

• Bad debt

• Assessing your own situation

• Things I found interesting

• Financial Tools

Good debt

Overview: Debt can be a great tool if utilized correctly. Things like real estate, business acquisition or personal development are great examples of how they can allow you to pursue opportunities that will potentially have a high return on investment (ROI). Just be sure to research the risks!

The details: Yes it is true. Debt can be a good thing as long as it used to acquire assets that will increase in value over time.

Real Estate 

Consider a $300,000 home. Few people have that amount readily available in their bank accounts. This is where strategic debt comes into play. By securing a mortgage, you gain access to an asset that typically appreciates over time. The bank provides the necessary funds in exchange for interest payments, creating a mutually beneficial arrangement.

Moreover, if you decide to relocate, you can transform your property into a rental, using the income to cover mortgage payments while still benefiting from potential appreciation. This strategy can lead to building long-term wealth through real estate.

Business Acquisition

Calling all future business owners! A lot of times when a business gets acquired, people use debt to purchase it because the buyer is expecting the business’ income will be able to pay for the loan or they want to be able to keep cash on hand.

Personal Development

Lastly, investing in yourself to obtain other credentials so you can get a better job is always worth the investment! This doesn’t just mean college. There are so many courses with certificates that you can complete for $100 (or less in many cases) available online. Taking these can allow you to get the qualifications needed in a much faster and less expensive manner.

Know of Potential Pitfalls

While strategic debt can be beneficial, it's crucial to approach it with careful planning and risk assessment. Consider these potential challenges:

1. Rental property issues: Non-paying tenants can disrupt cash flow. Research local tenancy laws and consider landlord insurance for protection.

2. Business volatility: Economic factors like inflation can impact profitability. Develop strategies to balance price adjustments with customer retention.

3. Educational ROI: Ensure the cost of acquiring new credentials aligns with potential salary increases to avoid financial strain.

Bad debt

Overview: Using debt in the wrong way can lead your finances spiraling out of control! Bad debt will have compound interest working against you, longer repayment periods and increased stress levels. Doesn’t sound like much fun.

The details: If you use debt for the wrong things, it will come back to haunt you financially if not managed properly. This is especially true for high-interest debt, which I will define as any debt with an interest rate greater than 8%. This kind of debt can have severe long-term consequences on your financial health and should be avoided.

Why High-Interest Debt is Dangerous

1. Compound Interest Works Against You

   • High-interest debt can quickly spiral out of control due to compound interest. This means you're not just paying interest on the principal amount, but also on the accumulated interest over time.

2. Extended Repayment Periods

   • With high interest rates, a larger portion of your monthly payment goes towards interest rather than the principal. This extends the time it takes to pay off the debt, keeping you in a cycle of debt for longer.

3. Opportunity Cost

   • The money you spend on interest payments could be used for more productive purposes, such as investing, saving for retirement, or building an emergency fund.

4. Financial Stress

   • High-interest debt can cause significant stress and anxiety, affecting your overall well-being and quality of life.

Suppose you charge $5,000 on a credit card with an 18% APR (Annual Percentage Rate). If you only make the minimum payment (typically 2-3% of the balance), it could take you over 30 years to pay off the debt, and you'd end up paying more than $15,000 in total - over three times the original purchase amount!

Some typical bad debts include:

• Credit cards

• Car loans (if longer than 4 years)

• Personal loans

Assessing your own situation

Overview: Evaluate your debts to see which ones are good and bad. For your bad debt, figure out how to reduce your expenses or increase your income so you can attack this! There are two main strategies for paying off debt: Debt Snowball and Debt Avalanche. Either method will work well.

The details: If you haven’t already, I would list out all of the debts you have and do a self assessment. If you don’t have any bad debts, pat yourself on the back for a job well done! Companies these days make it very easy to get into debt and you’ve managed to avoid that.

If you identify some bad debt, do not be discouraged. The first step to solving a problem is identifying there is one. Take a look at your budget and problem solve how you can attack this debt. Pause all investing until these debts are paid off. You can reference last week’s post on ways to save thousands. If you feel that you are having a hard time cutting expenses, another approach is to look at ways to increase your income. Some basic ways to do this include:

• Working overtime at your current job

• Pursing a higher paying job

• Taking a second job

After you determine how you are going attack the bad debt, you can use one of two strategies:

1. Debt Snowball

2. Debt Avalanche

The Debt Snowball method is when you pay off the smallest debt first regardless of the interest rate on it vs the Debt Avalanche is when you pay off the debt in order of the interest rate from highest to lowest. People will debate which one is better to be honest either one is good. I personally prefer the Debt Avalanche method. The important thing is you are making progress on paying down these bad debts!

Things I Found Interesting

• Construction of new U.S homes fall to four year low

• Frustrations mount in the Houston heat after Beryl moves on and leaves millions without power

• Americans are going into debt for summer fun. Many will still be paying it off a year from now

• 7 common mistakes when refinancing into a low mortgage rate

• Boeing will plead guilty to criminal fraud over 737 Max crashes

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I want to give a special shoutout to Kammy for being the first subscriber to have a referral! Your contribution is greatly appreciated. Keep being a rock star 🤘

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