Is today’s debt tomorrow's poverty?

By: J Lynne Stewart, MBA , Director of Practice Management, Worldsource Wealth Management

Have your parents ever told you stories about interest rates of up to 18% on their first mortgage? Can you even imagine? We live in a different time now, with the past decade's low-interest rates presenting the opportunity for many to take advantage of as a time to borrow, sometimes even against their own homes.

So, what do we do now that interest rates are rising and markets are slowing? What happens to the money we borrowed during the time of low interest? 

The math is simple. If you are paying more for debt than you are earning on your investments, the math doesn't work in your favour. On the other hand, if you are paying less for debt than you are earning on investments, then debt is working for you.

There are different types of debt or credit (as it is also called), and they each impact us differently - let's take a look at the basic types:

First, there's the best kind of debt, which we call "leverage," that can be applied to an investment. Let's take a mortgage, for instance.  

Think of it like this: if you borrow 80% of the value of your home and put 20% of your own money into the investment, you are earning returns on 100% of a property that you only put 20% of your money in. 

Tip: Wise investors take on real estate with a minimum of 20% down and a mortgage they can manage. They always seek to accelerate payments either through a weekly payment schedule or a shorter amortization.

Investors who instead borrow money to invest in the stock market need to be even savvier and ensure that they borrow at a rate lower than the returns they expect from their investment. This scenario has other nuances, including writing off the interest on an investment. Investments in a non-registered account can have a margin provided often up to 50%, thereby creating "leverage." 

You may wonder, what is an example of this strategy? The best example is borrowing money to invest in an RRSP to reach the year's tax-efficient contribution (Note: this type of loan is not interest tax-deductible).

There is also the debt we take on to purchase assets like vehicles. Now, why is this different from a home or the stock market? Because traditionally, we would view a vehicle as a depreciating asset or an asset that is losing value. 

Tip: Look for ideal times in the year when interest rates are low for a lease or financing of a vehicle. Always remember that vehicles are depreciating assets, don't over-invest! 

Then we have the bane of our existence (depending on how we manage it), revolving credit in the form of credit cards. Credit score agencies like Transunion and Equifax measure profiles differently based on the type of debt acquired, with this form often weighing heavily in a lower score. 

Tip: Credit card owners should strive to never spend more than 10% of the available credit across all their cards at any point in the month; this will benefit their credit score!

Debt in the forms of loans and revolving credit are accessible based on your income, existing debt levels and asset value (the real estate you are buying), with mortgages more robustly scrutinized than credit cards. This is why many consumers can more easily access expensive revolving credit card limits and, thus, why we as individuals need to apply better controls to how we manage this type of debt.

So back to the title, is today's debt tomorrow's poverty? 

It all depends on the type of debt. Debt for investing can make you wealthier, but debt applied to depreciating assets or the unbridled use of revolving debt at high-interest rates can impact one's ability to ever get ahead. So, let's be smart about debt.

Let's challenge ourselves to pay off the expensive debt in sprints and accelerate payments on our prime appreciating asset, our principal residence - taking on these challenges can result in a healthier, wealthier life!