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How You Can Use Debt to Build Your Credit

Catalina Kaiyoorawongs|Financial Topics|August 02, 2023
How You Can Use Debt to Build Your Credit

You should use debt to help your future and not trap yourself in a constant state of indebtedness. You just need to know the right types of debt to incur and how to manage them properly.

Rule of thumb:  Use debt to build wealth and only use it to invest in assets that will help you grow your net worth.

Educational Debt

For example educational debt. The reason debt for your education may make sense is because it's going to give you greater earning power. There are all types of evidence that say a college degree, for the most part, at a school that has good educational outcomes, such as good job prospects, a powerful alumni network, and higher than 60% graduation rates.

If people are not graduating in four to, maximum six years, on average, of a higher than 60% rate, then that's not a good place to invest and take out any type of student loans.

Secondly, what are you going to school for and what's the earning potential? Never take out more debt than your annual earnings. That's another rule of thumb. So if you're going to come out earning $70,000, I would use a rule of thumb of trying not to borrow more than 0.75% ratio of student debt to your earnings, which means that if I earn $100,000, I wouldn't take out more than $75,000. 

Education generally is a great investment because if you don't go to college and you earn $35,000 to $40.000 and you go to college and now you can earn $70,000 out of college, that extra $30,000 in your first-year earnings. Your prospect of wage growth over your lifetime may make college make sense. 

Debt and Mortgage

Another example of something that's worth investing in is, and I don't say this just because we work at the niche of student loans and mortgages, but investing in a home. A home grows in equity and grows in value over time. 

Car Loan Debt

Items that I would never take debt for, are things that depreciate or decrease in value over time.  I would personally avoid taking out an auto loan because an automobile decreases in value over time. That to me is not worth an investment.  I'm not going to take a loan for a $50,000 car that's going to become worth $10,000 in the next six years. To me, that's not considered an investment. That's a lifestyle item. 

In fact, my personal belief is that you should buy a car with savings you built over time. If I want to buy a new car or I need a new car in the next two years, I save for it over the next two years to minimize how much I need to borrow for the car. 

Minimize the amount of borrowing for the car. Also, consider getting a car that has a better resale value because that means you're losing less money over time.

An example of a way your car becomes an investment is Turo. If you put your car on Turo and now that car makes you money every month, then that might be worth an investment. But, if it's just for your own personal use to have a cool ride and it doesn't make you money, then it's more of a lifestyle item. Another example: if you're driving a Lyft and you're making money, it's actually used for your job, then it might be worth taking out a loan for because it's making you money.

Using debt as a financial tool will increase productivity or quality of life

The most important factor for positive credit is having a positive payment history (35%). The credit mix is only 10% whereas the positive payment history is 35%. It's more important you pay your debt on time than an exact mix of credit. You could boost your credit to 800 without having an auto loan. You could boost your credit very high with a positive payment history and longer average account length.

Using debt responsibly is using debt on items that grow in value, not on items that decrease in value. Also, paying on time is key.