For the most part, everyone’s introduction to credit is unique in some way shape or form. One common phrase that people are told is, “don’t spend what you don’t have.” Now at the surface, that makes sense. However, it may be more complex than that. That’s because properly managing credit to reap the most rewards does involve more planning than just “don’t spend what you don’t have.” In fact, there are a lot of ways that people can make the most out of their credit, even if they don’t abide by the don’t spend rule. Now keep in mind, the best practices depend on the situation. This rule of thumb may be great in a lot of instances! However, it’s important not to rule out the fact that breaking this rule of thumb can lead to some serious benefits. That’s why you want to consider consulting with a financial professional before making any decisions.
Understanding the Phrase: “Don’t Spend What You Don’t Have”
The exact meaning to this phrase can be up to interpretation but basically means consider credit as an “I.O.U”. What does that mean exactly? Basically, you should view your available credit as an extension of the money you currently have. For example, let’s say you have $200 in the bank, and an available credit line of $400. If you want to spend $250, according to this phrase, you shouldn’t. Instead, you should only spend up to $200 because that’s the most you have. Now while this makes sense at the surface level, it can be a little bit deeper than that.
The Pros and Cons of This Statement
Just like anything in life, there are pros and cons to consider. Starting with the pros:
- Promotes responsibility: When you are considering your financial ability with how you operate, you are training yourself to be more responsible!
- Helps you think about your finances: This tactic essentially makes you slow down and be aware of your finances if you abide by it. You may find yourself more conscientious of how you handle money.
- Reduces risk: If you are on the conservative side with your money, it can reduce the likelihood that you find yourself overwhelmed with debt.
While these are some great positives, there are also some negatives to be aware of. Some of the negatives of this statement include not making the most of your credit. When you purchase items “outside” of your current financial standing, you may benefit in the long run. So even though there is a short term loss, buying something valuable with your credit can be worth the short term hit. To that point, you may not be able to make the most out of available credit offerings. Some companies offer incentives for spending that actually add up over time. You may miss out on these benefits if you are hesitant to spend.
The Different Types of Debt
What a lot of people overlook when listening to this advice is that it’s possible to leverage your debt to help you become wealthier! The first step in understanding this concept is knowing the difference between good debt and bad debt. When it comes to debt, not all types are created equal. The world of financial obligation is split into two main categories: good debt and bad debt. ‘Good’ or ‘bad’, the labels given to these debts hinge on their potential effects on your long-term financial goals. But what exactly separates them?
Recognizing Bad Debt
Typically, this involves high-interest consumer debts such as credit card balances and car loans. A typical example is when you use your credit card for non-essential items, building up a hefty card balance. This type of card debt often carries steep interest rates which compound over time if left unpaid, making the total cost far more than the initial purchase price. This also holds true with some auto financing deals where interest rates may increase significantly after an introductory period. The result? You’re spending much more than you initially thought.
Identifying Good Debt
Good debt, as the term implies, can actually help build wealth over time. This is usually associated with investments that grow in value or generate long-term income. Consider student loans – yes, they’re a financial burden now, but education often leads to higher earning potential down the road. In essence, you’re investing in yourself.
Mortgages too are typically classified as good debts because real estate tends to increase in value over time and also offers tax benefits. Imagine buying your dream house today at its current price and watching it double or even triple decades later. That’s not just a home; it’s an investment.
Leveraging Debt for Wealth Building
Most people view debt as a financial pitfall. What if we said that, with the right approach, debt could be a useful way to increase wealth? The trick lies in leveraging debt in ways that a lot of people tend to overlook.
Understanding Leveraged Investing
The idea behind leveraged investing is simple: You borrow money at a lower interest rate and then invest those funds into ventures with higher potential returns. If the return on your investment exceeds the cost of borrowing, congratulations. You’ve successfully generated income using borrowed capital. This strategy might sound risky—and it can be—but there’s also plenty of opportunity. Say you borrow 10 grand at 4% annually but use it to make investments yielding 8%. After paying back the loan and interest, you’d still come out ahead by $400!
The world of credit offers diverse pathways for individuals. While the old adage “don’t spend what you don’t have” serves as a fundamental principle for many, the landscape is more intricate than it initially appears. Yes, following this principle can foster financial responsibility, conscious spending, and minimized debt risk. However, a more nuanced approach, recognizing the distinction between good and bad debt, can unlock opportunities for wealth creation. While bad debt, characterized by high-interest consumer expenses like credit card balances, can jeopardize one’s financial stability, good debt is a different story. Instead, good debt is often linked to assets that appreciate or lead to long-term income, which means they can be a strategic investment. Leveraging debt, when done judiciously, can pave the way for gains, as seen with leveraged investing. Thus, while foundational guidelines are invaluable, understanding the multifaceted nature of credit and debt can transform one’s financial trajectory. Hopefully this breakdown helps get the gears turning in your mind on how you want to handle your credit!