Many people fear debt and want to be completely debt free. Owing money to anyone else forces you to pay them money before you can pay yourself and out of control debt can wreck your financial future.
However, debt is really just a tool. Do we want to be free of cars, scissors, or butcher knives? Yes, debt is dangerous and so are all of those other tools. We must use our tools properly or we will suffer painful consequences.
So how can we use debt well? Let’s explore what debt is, when it puts you in danger, and when it can provide a boost.
What is debt?
Strictly, debt is any money you owe to a person or business. The most common forms of debt include:
- Bank loan: a personal loan from a bank that will typically require some collateral (building, stocks, etc.) against which the loan will be granted
- Business loan: a loan to a business using company collateral or earnings as the basis for the loan
- Car loan: a loan to purchase a car using the car as the collateral for the loan
- Credit card: a form of preapproved debt that allows you to consolidate and time shift payments to individual retailers
- Home loan: such as a mortgage or home equity line of credit using your house as collateral for the loan
- Margin credit: a loan provided by a stock broker to allow you to buy a portion of your stock portfolio on a loan backed by the stock
- Payday loan: a loan to an individual using their paycheck as the collateral for the loan
- Student loan: a loan to students to pay for college tuition and related fees; this is the only type of debt that might not be removed by personal bankruptcy
Collateral, mentioned many times above, requires an asset worth sufficient value to allow the lender to offer you the loan against that asset. The collateral may be seized by the lender if you don’t pay.
When you load up too much on debt and can’t pay it off, you can declare bankruptcy and officially notify creditors that you can’t pay them. This will lead to a court proceeding to reduce the total amount of debt you need to pay and legally remove some debt obligations.
However, bankruptcy will mess up your future ability to obtain loans and you can’t escape most student loans through bankruptcy. Also, some creditors will take the ‘bad’ loan that you escaped and sell it to a debt collection firm that will (legally and sometimes illegally) harass you into making payments despite your legal right not to do so. It can be a complete pain, so just try to avoid this mess and don’t get too much debt.
Of these types of debt, I have only used credit cards, card loans, home loans, and student loans. I never needed a bank or business loan, and I consider payday and margin credit to be dangerous types of debt. Let’s study why in more detail.
When is Debt Bad?
Debt becomes a problem when it becomes a burden or when it amplifies risk.
Burdensome Debt
When you can’t pay off the loan quickly, the interest will cause the overall total of payments to swell. If you can’t pay off the interest, the debt can also quickly balloon out of control.
We covered an example of this for a credit card in the article on emergency funds. However, it applies equally to other forms of debt such as home loans, car loans, or student loans.
A secure financial future requires you to live within your means and save money for the future, but debt acts as an anchor to drag you away from financial freedom. If you are not careful, it will drag you down and make you work for many extra years and you will give an extraordinary percentage of your paycheck to banks and other lenders.
According to CNBC, the average American will pay the following amount of interest over their lifetime:
- $142,614.31 in mortgage interest
- $4,450.96 to $5,833.38 for auto loans (new and used respectively)
- $5,994.07 in student loan interest
- $9,624.24 in credit card interest
However, most of my lovely children, nieces, and nephew live in Southern California where the homes cost much more and you will be much more likely to pay a lot more in mortgage interest. I know I did.
Also, with the rising cost of college tuition and cars, you will likely pay much more for those as well! I was fortunate to avoid paying any car loan interest thanks to the generosity of my parents as well as Toyota Financial’s zero-percent loan (which they stopped offering).
You will have the most control over credit card interest payments and I paid under $100 over my lifetime. My principle is to always pay my entire balance every month and to pay no interest; however, I think I messed up one or two payments in my youth.
When you manage your money well, one or two mistakes won’t become a big problem.
Risk Amplifier
Debt amplifies risk, especially when it becomes large. However, most debt will have a legal clause (or portion of your agreement) attached to it that can amplify, or increase, the danger even more.
We already covered the common student loan clause that the loan can’t be removed by bankruptcy. Another common example is that if you fail to pay your auto or home loan, the bank can take your car or your house.
These can become a compounding problem. For example, you probably need your car to work, so if the bank takes your car, you become less able to work and less able to obtain the income you need to pay off the debt!
Fortunately, most asset backed loans will not take action as long as you continue your payments. This means that even if you lose your job and your income (which I have), as long as your emergency funds cover your payments, you will be OK until you can start up your income at the next job.
Not all loans work that way. An especially dangerous form of loan is the margin loan offered by a brokerage firm to allow you to buy more stock.
People love the idea of buying $1,000 of stock with $500 so they can make more money if the stock doubles in value (less the margin interest rate costs). However, this relies upon the illusion that you will be correct in guessing the stock will go up.
If the stock drops in price, you will be asked to either add more money to your account (pay off the margin), or the brokerage will automatically sell the stock to cover the loan. Consider the following scenario.
| Using Margin | Buying With Cash | |
| Buy $100 stock | Buy $10,000 (100 shares), use $5,000 margin at 0.0325% per day | Buy $5,000 (50 shares) |
| Stock rises to $120 in 10 days | Hold, $10k now worth $12k (margin balance to $5,014.78) | Hold, $5k, now worth $6k |
| Stock drops to $80 for the next 10 days | Forced to sell and repay $5,031.25 in margin. Loss of $2,031.25. | Hold, $5k, now worth $4k |
| Stock rises to $120 over another 10 days | Too bad, stuck with $2,031.25 loss | Sell for $6k, you made $1k. |
When buying on margin, most only see the upside and think about how they can double their profits. Sadly, they don’t consider how they can be right about the final results and wrong long enough to lose money. Margin stock purchases just aren’t worth the risk.
When is Debt Good?
Simply, debt is good when it makes money. Debt can help time payments, reduce future costs, and help make additional money when used well. Let’s examine a few scenarios.
Benefits of Payment Timing
The best example of payment timing using debt is a credit card. If you don’t use a credit card, you either need to withdraw cash or use a debit card to make purchases. However, when we need to spend money doesn’t always match when we receive our paychecks.
For example, you may start with and want to keep a minimum of $1,000 in your checking account, receive $1,500 twice a month in income, and have to spend $2,000 for expenses. In theory, that should be no problem, but only if you can time the payment of the $2,000 after you receive the paychecks.
Credit cards are a convenient way to push payments for many purchases to a later date. This added flexibility also can contribute to higher income or reduced expenses.
That $1,000 minimum could be required to avoid additional bank fees. Alternatively, if you can perfect the payment timing so you don’t need the cushion in the checking account, you could move that $1,000 into a high-yield savings account or a certificate of deposit to increase your income.
Benefits of Reduced Future Costs
A home loan provides the primary example for how to reduce future costs through debt. While it may apply to some degree internationally, I’ll focus on the Southern California example which I used for myself and for which I have more data.
Homes in Southern California are expensive. Apartments.com shows the average rent in California (as of August 2026) for a 1 bedroom apartment to be $2,266 per month. Southern California rents easily exceed this average in Irvine ($2,964 / month), Huntington Beach ($2,522 / month), San Diego ($2,427 / month), and Oceanside ($2,274 / month).
However, rents in California can also increase at a steep rate. Although 2026 rents in Los Angeles and Long Beach dropped 1.9% in 2026 to $2,709 per month, between 2010 and 2019 the average LA rents increased 65% – much higher than the 36% national average.
This suggests you can expect rents to generally increase between 4% and 7% a year unless you can find a rent-controlled apartment. Yet many people rent because home prices seem even more expensive.
The average American monthly mortgage is only $2,023 per month, but in California, the average jumps to $2,668 – over 17% more expensive than the average Californian rent! However, if you obtained a fixed rate mortgage, your payment is locked in and won’t increase – typically for 30 years.
So if you buy a home, it will cost you more than renting for the first few years, but after roughly 3-5 years (based on 4% to 7% rent increase per year), your home mortgage could be less than the equivalent rent. Naturally, it isn’t exactly this simple in real life because most homes are bigger than an equivalent apartment and there are other costs and tax benefits (a topic I’ll cover another day).
Still, the lesson remains sound. If you can purchase a home that you will live in for an extended period of time, you will wind up saving money on rent by taking on the debt of the home loan and fixing the costs that would otherwise increase.
Benefits of Additional Income
Additional income might initially seem counter-intuitive. How can a required payment (decrease in your money) lead to income (increase in your money)?
I offer two examples I personally used: a car loan that helps you commute to a job and a student loan that helps you invest.
Car Loan Benefits
This might be alien to people who live in cities with robust public transportation networks, but in Southern California, you need a car for many jobs. For example, a 1-2 hour commute from Torrance to Malibu (one way) becomes a 3 hour commute with 40 minutes of walking to and from bus stops! A car saves that specific commuter at least 2 hours a day.
In some cases a distant location, an early start date, or a late ending time might mean that there will not be any usable public transportation option. Therefore, without a car, you might have your income potential dramatically reduced.
A car loan makes the car possible and therefore also makes possible the increase in income from a future job or to even keep the job you currently have. There are limits of course.
You can’t justify a Ferrari car loan for a $10,000 increase in pay. You also don’t want to pay expensive car loan rates (Bank of America currently advertises over 5%) if you can afford to buy the car directly and skip the payments and the interest amounts.
Still, if you can use the car to increase your paycheck, taking on a car loan may be a useful and justifiable debt.
Student Loan Benefits
Student loans help you to obtain college degrees which can also help you to obtain higher paying jobs. There may be jobs you simply can’t get without the degree and the student loan can make that job, and its income, possible.
For me, I took out around $75,000 in student loans to obtain my Masters in Business Administration degree from the University of Southern California from 2002 to 2004. I was able to directly translate that debt into increased income in my next few jobs.
There was also a hidden benefit to the loan that I didn’t enjoy as much as I could have. I was fortunate enough to experience a period of low interest rates and increased student loan lender competition so I could consolidate my student loans for less than a 2% interest rate.
I initially tried to pay off my loans as quickly as possible and made extra payments. Then, I realized that I could invest those extra payments instead and make 3% additional income!
I found a real estate income trust (REIT) called Realty Income Corp (stock symbol: O) that offered a 5% dividend rate at the time. Instead of paying off my student loan early, I could apply those payments to purchase O and the student loan would be financing my future retirement with the difference between the 2% interest rate and the 5% dividend rate!
Over time, this proved to be a strong benefit, but you need to be careful about when and where to use it. You must be obtaining a strong degree worthy of the loan and you must have an investment whose return exceeds the interest rate on the loan with a reasonable guarantee.
For example, as much as I love music, I probably could not convert a music degree into higher income because of competition for jobs, my lack of discipline to practice, and my lack of skill. Similarly, while I have done fairly well picking winning stocks, if I were to have put my student loan into a non-dividend paying CIT stock that eventually went bankrupt, I would have suffered.
I made sure to invest in a stock that had a decades long track record of dividend payments that at least covered the interest payments even if the stock might go up or down in value. I also only invested funds that would be used to pay off the loan early and not funds I might need to make my monthly loan payments.
Use Tools Well or Not at All
Debt is a tool. Like a pair of scissors, you can use it well and benefit, or you can hurt yourself if you use it poorly.
Ideally, you start by testing yourself with small debt risk such as a credit card. Once you prove you can manage your debt payments, then you can escalate to larger debt such as a car, student, or home loan.
However, if you find you can’t stop running with scissors or you can’t control your spending, then maybe scissors or debt aren’t useful tools for you until you mature. Know yourself and use the tools well, or save yourself from yourself and don’t use them.