The Only Good Debt is Profitable Debt – 3 Ways to Get There
Running a business involves a lot of financial decision-making, and some of it involves whether to take on debt and if so, what type. Some of the decisions also involve structuring retirement savings for the future, and this brings personal finances into the picture as well. The tips and suggestions here are applicable to both business and personal debt, and often a small business commingles both.
The title statement that the only good debt is profitable debt is a rule you can live by, and if you do, you will find that your nest egg builds faster and your business will be healthier in the long run. These are some simple yet critical rules and tips for eliminating your unprofitable current debt and only taking on “profitable debt in the future.
What is profitable debt? If you buy rental property, the mortgage can be considered profitable debt. This assumes that you have made a well-researched purchase decision that is generating profitable cash flow and over time appreciating in value. Buying some business or production equipment with debt financing could be considered profitable if it expands your income ability and you pay it off quickly from the extra income it generates.
Financing a vehicle would usually not be considered profitable debt unless you are an Uber driver and dedicating it to the business. The tax advantages could help you on both the business and personal sides of your finances. However, if the vehicle is not generating business income in some way or cutting taxes significantly, it would probably not be considered good debt.
Now that you are on track with what is considered good and profitable debt, it is time to work on reducing your current debt that is not profitable. This is debt that drains your finances over time with interest charges that in some cases are in the double digits.
Step #1-Start by: Make sure that you do not fall behind or default on debt payments. Make at least minimum payments to maintain your credit rating for when you want to take on some profitable debt. Also begin to put away some money into an emergency fund that you build over time to help to fund an emergency instead of having to take on credit card debt.
Step #2-Choose between the Debt Avalanche and the Debt Snowball methods to reduce debt: Both the avalanche and the snowball methods will get the job done, but you may see that you will find it easier to stick to one over the other. Both methods require that you begin by setting up a spreadsheet of all your debt so that you can rank it for one of the two methods. Once you have them all listed, choose how you want to proceed. The two choices are briefly differentiated by how you begin:
- The debt avalanche method has you beginning by choosing the single debt that has the highest interest rate as the one you address first. This method can result in lower overall money paid over time, as you are retiring the highest interest rate debt first.
- The debt snowball method has you starting with the smallest debt balance first regardless of interest rate. This method is often preferred as you begin to build momentum and excitement faster by eliminating debts sooner.
The premise of both is that you continue minimum payments on all but the target debt while you pay it off as quickly as possible. Then you move to the next one based on which method you chose. You apply as much extra money as you can toward paying off the target debt, then you move on to the next one. Keep working your avalanche or snowball until all your unprofitable debt is paid off. Keep your credit cards, but only for short term convenience, paying them off monthly if you use them.
Step #3-Finally, go out and get some good debt: Now that you have climbed out from under that mountain of debt and have some funds you can put to work, do so. You could invest in stocks or bonds but consider real estate or other investments that generate income or profits. Good debt is using the money of others in ways that add to your income and net worth, not subtract from it.
Step 1 is easy, as you are probably already doing that. Step 2, however, takes longer and requires dedication to the effort. However, it is extremely rewarding as you watch your debt disappear. Step 3 is just fun and profitable.
SOURCE(S)
https://www.experian.com/blogs/ask-experian/what-is-the-avalanche-method/