Financial Tip of the Day #8 - Your Debt Might Not Actually be a Bad Thing!

What if I told you that you could actually make money off of your debt? There's a common misconception about the word "debt." You see, debt actually has a lot of benefits, and might be worth paying off slowly. You're probably thinking in your head, "Now why the hell would I do that? I'm just losing money as they accrue interest against me!" Well, if you are thinking that, you're certainly not wrong. The loan organizations are accruing interest on you, BUT you might be able to make that debt work for you so it's actually making you money.

There's three ways that I'll talk about in regards to how our debt can actually benefit us in a financial way - credit, taxes and financial gains/losses.

Credit

Your credit score is incredibly important. It determines the percentages you'll be paying on loans, what loans you can get, and what credit cards you can receive, among other things. By paying off debt whether it be credit cards, mortgages, or other types of loans, you're improving your credit history. It might not be a huge deal when you're younger, but the percentage difference on your mortgage can save you tens of thousands of dollars. Take the steps now to improve your credit score for the future!

Taxes

If you're diligent enough, the tax code has been designed to benefit you in a lot of ways. There are a ton of deductions and credits that can help you limit your tax liability. In fact, I have received EVERY dollar I paid in taxes as a refund for each of the past THREE years. How did I do this? I took advantage of the deductions and credits that I was eligible to receive. 

When talking about taxes and debt we want to talk about interest. The common forms of debt that people are able to deduct are student loans and mortgage debt. Through student loan credits, I have taken a 2,000 credit (equivalent to roughly $8,000 in earned income) off of my taxes. Due to the scope of this post, I'm not going to go into all the specifics. That being said I'll include links for two of the more common types of tax deductions related to interest. There is a ton of information available on the following types of deductions and credits - student loan interest deduction, american opportunity credit, lifetime learning credit, home mortgage interest deduction.

Student loan interest deduction - https://www.huffingtonpost.com/aryea-aranoff/student-loan-interest-ded_b_7486888.html

Home mortgage interest deduction - https://www.irs.gov/publications/p936

Financial gains/losses

The second way that debt can actually be a good thing is if your interest rate is low enough that you can earn more on your investments than you'd be losing by keeping your loan! Let's put this into some numbers.

You currently have a loan for $10,000 with a 5% APR. Historically, you have earned 7% on the stock market. You could pay that $10,000 off today, or invest that money into the stock market. For example purposes we'll assume you're in the 15% capital gains tax bracket.

Pay off the loan - $10,000 - $10,000 = 0

Invest the money - $10,000 * 7% * (100% - 15%) + $10,000 = $10,595 - $500 (interest) = $10,095. 

In essence, by investing the $10,000 you would have used to pay off the loan, you actually netted $95 more. Depending on your tax information, you may even be able to get some or all of the capital gains tax back as well.

I personally used these ideas in my own life recently. I have multiple student loans with interest rates ranging from 2% - nearly 9%. I messed around with the numbers and was able to figure out that my smartest option right now is actually to pay off my highest interest rate loan, and then pay the standard monthly payment on the rest of the loans until they're fully paid off. By doing this, I can capitalize on earning income with the money I would have otherwise not been able to invest, AND taking advantage of the tax deductions/credits that I now have at my disposal. 

Everyone's life situation is different. You may be eligible for certain deductions that I am not eligible for, and vice versa. However, you may be surprised to find out the amount of money you could be saving by leveraging your debts. 

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