Have you ever heard the phrase “Debt is the root of all evils, never get into debt, debt is slavery” and that is true to a certain extent because when you are drowning in debt your life is over. While you’re trying to pay your debts, those debts are not waiting for you, they are growing day by day since no one lends money for free, there is always an interest.
Despite all of this the United States has embraced debt. Total U.S consumer debt is almost $15 trillion which makes the average household debt to over $5,300. The U.S GDP is a little over $21 trillion which means the entire economy consist out of debt.
Debt is an unpopular opinion because most of the debt we have is bad debt and you probably have some credit card debts, car loan or maybe a student debt and you are thinking “it will probably take me decades to pay off all of these debts.” How on earth can that be something good?
In order to understand how debt can be something positive let’s take a look at how people with “deep pockets” still use debt to make even more money. It might sound a bit confusing because why would anyone with a lot of money debt in the first place. That is supposed to be used by people who do not have money and that’s not how capitalism works.
1. Most Of The Trade Is Based On Debt
It might sound a bit controversial because borrowing money to start a business is a horrible idea and personally I would never do that. There are businesses especially traditional business where using debt is your best option. Let’s say you want to sell pens which is a very common product and there’s pretty much always a demand for it.
Ideally you would fly to china, find a factory that produces that kind of pen with good quality and the right price. You would purchase a container of pens, ship them to the U.S and distribute them to your clients but today that’s mostly done online through websites like Alibaba unless it’s a more complicated product where you have to fly to that factory but here is the catch.
We don’t really have to pay for the products to have the product first. Let me explain how, in the past 50 years China has become the factory of the world producing literally everything. Thousands of factories work non-stop to produce everything that the world needs and in order to make it easier to sell , most of these factories would gladly loan you their products and in return that you would pay them some time in future.
Of course they would not lend to strangers so you will have to build some kind of trust with them first but that’s how business has been running for the past 50 years. Once the client would sell the product in the U.S or any other part of the world, he would pay the factory and borrow more products.
You are basically telling the factory you know how to produce it so let me help you sell it. If I can sell it for anything above this given price that’s going to be my profit. What makes this strategy great is that you’re not tying up your own money in this transaction, that’s why selling is one of the greatest skills you can ever master.
Real estate debt is the best kind of debt because it’s filled with loopholes. If you don’t have a mortgage, then you’re paying extra taxes. Rich people always have multiple mortgages to be able to get all of those deductions.
Every dollar that you are supposed to pay in taxes but instead what you save is an extra dollar earned. So that’s another way rich people get richer but let me give you a more practical way and that is through real estate.
Let’s say you saved $200,000, that’s a lot of money but if we’re going to be honest that’s peanuts, you can’t even buy a house. Of course you can get a mortgage up to $800,000 since you have to make a 20% down payment but here is the secret.
If you find a property that costs you $500,000 and it’s in a bad condition, needs some or a lot of renovation. You head to a bank and get a mortgage by making a 20% down payment. Let’s say you’re going to spend around 10% of the total cost of the house to renovate it or around $50,000 and you head to the bank again but this time to refinance your mortgage.
When you have your first mortgage, the value of that property was just half a million dollars ($500,000) because it was in such a bad condition that no one wanted to live there but since you have renovated it now there are people who want to rent it out. This makes the market value of that property to rise up to probably $700,000.
If you’re going to get an 80% mortgage theoretically but 80% out of $700,000 is $560,000. $400,000 out of that money is going to go to you first bank that gave you the first mortgage. Let’s deduct another $50,000 that you spent on renovation and you’re going to be left with an extra profit of a $100,000.
You’re further left with a property that you can rent out to build equity and generate passive income. On top of that, you’re going to avoid paying taxes because you have a mortgage. This is a very common practice among real estate investors.
3. Hedge Funds
Hedge funds are made by the rich, for the rich to make rich people richer and they usually use unpopular strategies. Normal people like you and I make our best effort to predict which companies are going to grow and rise in value and invest the money we work so hard to earn in hope for these companies to grow but hedge funds often use a completely opposite strategy.
They try to make money when companies fall or go bankrupt as it was with the case of GameStop. Although in that case, the internet challenged hedge funds and pushed them to lose over $13Bn but how do hedge funds make money with debt?
For example, you expect a certain stock like Facebook or Instagram to decline because you know that Apple who produces the most popular smartphone will announce next week that they will no longer let apps to track your online activity and make privacy your first priority which will greatly damage Facebook’s business model.
You proceed to call up your broker to borrow from him a single Facebook stock that may cost about a $100 and instantly sell it in the open market the same price. Now you have a $100 in your pocket but you still owe your broker one Facebook stock. If this turns out right for you and the stock price continues to drop to about $70, you use that $100 to buy one Facebook stock, return it to your broker and pocket the difference. Congrats, you have made $30 out of a full offer stock.
It sounds simple in theory but it is extremely difficult and risky in practice. What happens if you are wrong? What if the price doubles overnight, you still have to return that single Facebook stock to your broker and pay interest for borrowing that stock. Now you have to buy that stock for $200 to return it to your broker.
When you buy a stock and try to sell it when it rises, the maximum that you can lose is the amount you invested in but not in the case of shorting. If the price keeps rising, your losses keep rising. Theoretically, you can make unlimited losses since theoretically the stock price could rise indefinitely but if you have a hundred analyst working for you, you can make a fortune for using this strategy.
Forex is a market where currencies are traded international trade possible. You can’t use U.S dollar in china. You have to buy Chinese yen to pay your employees. For example in China, there is a market where anyone or any company can come in and purchase foreign currencies and based on their different factors, these currencies fluctuate.
For example, the fed raises interest rates, that’s what limits the supply of dollar in the market and make the U.S dollar stronger against other currencies or vice versa. If you can predict which currencies will rise or fall, you can make a lot of money in this market but what makes this market so different from the rest is that for every dollar you use to trade in Forex, you can borrow an additional hundred dollars.
That means if you trade using your $1000, you can hold a position worth a $100,000. If you end up making a small profit like 1% it will huge.
5. Credit Score
As you know, debt is a powerful tool. Every successful business, company or entrepreneur uses debt in various ways especially if you have a proven business model. Borrowing money to finance purchase orders is practiced pretty much by every business so stop thinking in terms that all debt is bad.
Of course debt with a high interest rate such as credit card debts is horrible but in order to get a lower interest rate you have to minimize the risks of loaning your money and how do you do that? You build a track record of being a reliable borrower.
There are billions if not trillions of dollars in the banks waiting for someone to borrow them.