Books, blogs and financial programs all have a message for you: Ditch your debt.
However, some finance experts say that advice is short-sighted. “Debt is a tool,” says James C. Kelly, vice president and wealth strategist with financial firm PNC Wealth Management. He likens debt to a hammer. Depending on how debt is used, you can make something great or cause significant damage.
And while high-interest credit card debt isn’t advisable, other forms of debt can be leveraged to make money. A mortgage can buy property that will appreciate in value, while student loans can lead to a degree that opens doors to higher-income professions.
Shannon Lynch, a senior financial advisor with online advisory firm Personal Capital, says people need to be smart not only about when they use debt, but how much debt they incur. She recommends that your total debt, including a mortgage, not exceed 36 percent of your household’s gross income.
While every family’s situation is different, here are five times when it may be worthwhile to go into debt.
Higher education. You’ll increase your chances of getting a good job if you pursue a college degree. Since 1991, good jobs for those with only a high school education have declined, while those that require some postsecondary training increased by 3.5 million. And jobs requiring a bachelor’s degree doubled from 18 million to 36 million, according to a 2018 analysis by the Georgetown University Center on Education and the Workforce, which defines a good job as one that pays at least $35,000 and has a median income of at least $56,000 for those without a four-year degree.
“A college education is not an inexpensive proposition,” says Scott Witherspoon, chief credit officer at Affinity Federal Credit Union. Scholarships, grants and work-study programs can defray costs, but many students still need to take out loans. And though student loans can be a smart use of debt, it’s important that the program the student is enrolled in will lead to a job with an income that’s high enough to justify the cost.
Housing. Mortgages are another common form of debt. “There are very few people who are in a position to pay cash for a home,” Witherspoon says.
The housing market crash preceding the last recession is a grim reminder that mortgages come with risks. Subprime loans with variable interest could quickly become unaffordable if rates begin to rise. Lynch warns against letting housing costs, which include principal, interest and insurance costs, exceed 28 percent of your gross income.
However, buying an affordable property with a fixed-rate mortgage can be a smart use of debt for property that has historically increased in value over time. What’s more, interest and property taxes can be written off on federal tax forms by those who itemize their deductions.
Investments. Some people borrow money in order to invest in the stock market. The math for this investment strategy may work out if the current bull market and low interest climate continues. However, it can also be a risky proposition since market downturns can occur with little to no warning.
A better way to invest using debt may be to buy rental property. Those new to this type of investment should consider getting professional guidance and avoid taking on too much debt initially. Kelly says a good guideline is to borrow no more than 50 percent of an asset’s value. Even that may be too much for some people, depending on their financial situation.
People should only go into debt for an investment if they are confident they can earn more than the debt will cost them in interest charges or other fees.
Business. Buying or starting a business is another form of investment that may require debt. Capital may be needed for a storefront, inventory or salaries, and in many cases, businesses wouldn’t be able to grow without access to credit. A 2017 survey of 503 small business executives conducted by the U.S. Chamber of Commerce found that 77 percent say cash from financial institutions is important for small businesses to succeed.
As with other types of borrowing, Lynch says people need to understand how a debt will affect their bottom line. According to Lynch, the type of question that must be answered is: “What sort of income can this help me yield?” Having a business plan and repayment strategy are also important and necessary steps before taking out a business loan.
Transportation. Since cars are depreciating assets, not everyone thinks it makes sense to go into debt to afford an automobile. However, Witherspoon says you may not have a choice. “Earlier in life, debt is something of a necessity,” he says.
Having reliable transportation is critical to maintaining employment, but not everyone has cash for a vehicle. In that case, taking out a loan for an affordable used car can be a smart strategy. A common rule of thumb has been to put 20 percent down on a vehicle and pay off the balance in no more than four years. Ideally, the car payment and insurance premiums shouldn’t exceed 10 percent of a household’s gross income.
Witherspoon says people should be more wary of going into debt as they get older. “When you reach your golden years and enter retirement, it’s important to not have this burden of debt hanging over you,” he says. Still, before you start planning for retirement, debt can be a tool to help further a family’s finances.
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