Key takeaways
Not all debt is created equal; some forms of debt have the potential to help you achieve your financial goals.
Forms of debt such as home mortgages are often considered “good,” while high interest credit card debt is often used as an example of “bad” debt.
A securities-based line of credit, home mortgage or HELOC, and estate planning debt are types of financial leverage that, when used wisely, may help support your long-term wealth.
For most Americans, debt is a common part of life; U.S. household debt reached $17.69 trillion in Q1 2024.1 Although many people don’t like to take on debt, it’s not inherently bad. In fact, some forms of “good” debt can be used as leverage to help you take advantage of financial opportunities.
Let’s explore how to tell good debt from bad and how to leverage good debt to help you achieve your financial goals.
Good debt is money you borrow for something that has the potential to increase in value or expand your potential income. For example, a mortgage may help you buy a home that can appreciate in value. Student loans may increase your future income by helping you get the job you’ve wanted.
“You don’t want to be overleveraged in any way, shape or form, but leverage in moderation can be a really powerful tool.”
David Mook, senior vice president and chief private banking officer, U.S. Bank Private Wealth Management
In other words, good debt is often considered an investment you’re making for a future outcome.
“Good debt can help borrowers accomplish an objective, or help them avoid a bad outcome,” explains David Mook, senior vice president and chief private banking officer for U.S. Bank Private Wealth Management.
Good debt also is more likely to have a lower interest rate or annual percentage rate (APR) than bad debt such as credit card debt, meaning you’ll pay less in the long run to borrow it.
Whereas good debt can be seen as something that contributes to greater wealth over time, bad debt is borrowing for something that you consume quickly or something that depreciates in value.
“I would equate bad debt with taking on too much risk without the ability to repay it,” says Mook. He adds that “borrowing to support ongoing living expenses is not a good use of debt.”
Typically, bad debt doesn’t help you make progress toward your financial goals. The best example is high-interest credit card debt, especially if you can’t pay off your balance each month.
Whether a given type of debt is “good” or “bad” depends on several factors, including:
Overall, debt is considered good if it’s used properly and can help you achieve your financial goals and build long-term wealth. Bad debt, on the other hand, is debt that can harm your credit and deplete your finances if you’re not careful.
Of course, with any type of debt, careful consideration is essential to ensure your debt is manageable and you’re not putting your personal finances at risk.
Understanding the difference between good debt and bad debt, let’s explore how you can use good debt to make the most of your financial future. It hinges on a concept called financial leverage.
Financial leverage is when you use borrowed money to potentially amplify returns on an investment. “This type of debt can be a part of your personal financial strategy if you employ it in moderation and use the right tactics,” Mook says.
Say you’re investing $100 with an expected 10% rate of return. If you invested $100 of your own money, you would earn $10. But if you invested only $50 of your own money and borrowed the remaining $50, the same $10 would represent a 20% gross return on your invested capital of $50. If the interest on the loan is less than 10%, your net rate of return will be higher using leverage. In this example, says Mook, “you leveraged your return.”
Another example of financial leverage is when you use a loan to diversify your investment portfolio, such as if you hold a concentrated stock position in a single company. You could borrow against that concentrated position to buy stocks in other companies, resulting in a more balanced long-term investment strategy.
“You don’t want to be overleveraged in any way, shape or form, but leverage in moderation can be a really powerful tool,” says Mook.
Here are three types of financial leverage that could help you reach your financial goals: liquid asset secured financing, home debt and estate planning debt.
A liquid asset secured line of credit is like a home equity line of credit (HELOC), except it’s secured by your investment portfolio instead of your home. This allows you to access liquidity without the need to sell assets and therefore potentially incur capital gains taxes from the sale of the assets.
Liquid asset secured financing may be a good option for you if you need to generate cash flow quickly. It also offers the benefit of lower-interest rates, as it’s a lower-risk option.
Uses for liquid asset secured financing include:
A house is an asset on its own, but you can also leverage its equity. You can use money from either a second mortgage or a HELOC to buy a second home, renovate an existing home or purchase a commercial property. Doing so can generate income while also diversifying your portfolio.
Leveraging your home is a higher-risk way to borrow, but for those with a higher risk tolerance, the advantages of real estate investments are clear:
Contrary to popular belief, debt can facilitate wealth transfer. Two estate planning strategies could help: life insurance policies and grantor retained annuity trusts (GRATs).
Life insurance policies
Add this as another reason to have life insurance: You can use your policy to help pay for estate taxes after your death. Leveraging your life insurance policy allows the estate to distribute assets at a pace that maximizes the estate’s value.
Mook notes that insurance can be expensive. “If you don’t want to write a large check every year,” he says, “you can finance that premium and use the cash value of the policy or other assets as collateral for the loan.”
Grantor retained annuity trust (GRAT)
A GRAT is an irrevocable trust set up for a short time (usually two to five years) that helps transfer assets to beneficiaries in a tax-efficient way. You place assets into the trust and the trust pays you a fixed annuity each year, usually a set percentage of the original amount of assets.
Over the life of the GRAT, the assets will inevitably rise and fall in value. Bank financing could help protect your gains and shield you from losses by allowing you to substitute a stable asset for a high-growth one.
For example, substituting cash for stock secures any gains in the stock value to date. If you don’t have the cash to make that substitution, a bank can lend it to you.
When the terms for your GRAT are up, the remaining assets, including any appreciation on the assets, transfer to your beneficiaries tax-free. However, if you’re no longer alive when the GRAT terminates, the assets become part of the estate and subject to estate tax.
By understanding the types of debt you have and how they’re either helping or hurting your finances, you can gain more peace of mind about the future. And in general, financial leverage can be a smart strategy if you know which tactics will work best for your situation.
“We want to give our clients flexibility,” Mook says. “By helping them use leverage, we can make sure they’re able to take advantage of financial opportunities when they become available.”
If you have questions about which debt strategies are available to you, consult with a financial professional. They can help you come up with a personalized plan to ensure you’re using debt in a way that supports your overall financial goals.
Leveraging the assets in your investment portfolio through a flexible line of credit can provide quick access to cash.
Just like your financial goals, insurance policies are as unique as you are.
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