Taking on additional debt creates understandable concerns for most people, because all credit comes at the cost of interest. Judicious borrowing focuses on using debt to finance or invest in things that provide long-term benefits, such as purchasing a first home rather than financing a home entertainment system. By focusing on the long term and employing judicious borrowing, you receive a number of benefits.
Build Your Credit Score
When you first join the adult world, you possess no credit history. A lack of credit history makes future borrowing to purchase a new car or home difficult. Securing small lines of credit, such as a low-limit credit card, and making regular payments allows you to establish a credit history and build a credit score. Lenders use credit scores to determine not only if they will lend you money, but the interest rate you must pay to borrow from them. Establishing a credit history and working to maintain a good credit score, you set yourself up to borrow later in life for more-expensive purchases and better interest rates.
Finance Large Expenses
Buying a home and financing a college education represent two of the largest expenses in your life and, in most cases require financing. In the case of education, the financing comes through a combination of government loans, grants and any scholarships you secure. Buying home typically calls for a mortgage. If you're looking to open a business, you can expect to need a line of credit from a bank or investment from an angel investor or venture capitalist. Without debt, opening a business, attending college or opening a business remains out of reach for most people.
The government offers a wide variety of tax breaks related to debt. In general, you can deduct the interest you pay on mortgages or home equity loans, student loans and even the interest on small-business loans. According to MarketWatch, even investors can take advantage of interest-related tax breaks if they take on debt to make taxable investments. The interest on the debt becomes investment interest and serves as a deduction on your taxes.
Free Up Cash
While incurring debt does mean paying interest, securing long-term financing at a low rate can free up cash to use in other ways. For example, buying a house with cash might eat up all your savings, leaving you no cushion for repairs or other emergencies. Borrowing might also leave you with cash that you can invest elsewhere to make a return that's higher than the interest rate you are paying. Borrowing to refinance other debt can get you lower payments that can free up cash you can use for other things. If you do so with a home equity loan, you also can deduct the interest, providing an additional benefit.
- BB&T: Developing and Using a Wise Borrowing Strategy
- MyFICO: About Your Credit Score
- Forbes: Five Expenses that Will Consume 50 Percent of Your Lifetime Earnings
- Mint.com: It’s the Biggest Purchase You’ll Ever Make…Don’t Mess It Up
- MarketWatch: How to Get Tax Breaks for Your Debt
- MainStreet.com: When It’s OK to Carry Debt