How to Use Debt to Build Wealth

Whether you’re looking to establish a strong credit history, buy a home, or invest in education to increase your earning potential, using the right type of debt correctly, may help you build long-term financial success. 

Below, we explore smart ways to use debt to your advantage.

Table of contents

• Make a plan to include debt in your budget
• Measure your ability to take on debt 
• Build a credit history to increase your wealth
• Understand “good debt” vs. “bad debt” to help build wealth
• Explore how borrowing might increase your home’s value
• Borrow for education as an investment in your future
• Consider a personal loan to improve your financial health

Make a plan to include debt in your budget

Creating a budget allows you to plan for your debt repayment. This is the first critical step in managing debt responsibly. If you’re still in school, just starting a career, building a family, or saving for a home or retirement, one of the first things to know is how much debt your budget can absorb. You want to make sure that your debt repayment leaves you room for everyday expenses and savings. 

A budget may also help you see ways to improve your financial picture. You might notice places where you can spend less, for example. A good rule of thumb is the 50/30/20 rule, which suggests you put 50% of your after-tax income toward paying expenses or “needs.” 30% may go to “wants” and 20% to savings and building wealth. 

Measure your ability to take on debt

The next step is to think about your tolerance for debt. That is the amount of debt you can comfortably take on. To know your debt tolerance, do the math to see how new debts and payments will affect your monthly budget.

Another way to measure how much debt you might manage is by looking at your debt-to-income (DTI) ratio. This compares the amount of money you owe with your overall income. It accounts for all monthly recurring debt and expenses, such as housing, credit cards, and other loans. Lenders may use your DTI as one measure of creditworthiness when assessing a loan application. You can use it to think about how comfortable you are with your current debt level and what changes you might want or need to make.

Build a credit history to increase your wealth

A strong credit history may also help you improve your financial picture. Many people begin with a credit card. By using a credit card for purchases and then making on-time payments, you can start to build a positive credit history. 

Often, when you are first approved for a credit card, you receive a lower credit limit. Once lenders see that you have a history of timely payments, they may increase the amount you can borrow. If you have a good history of paying bills on time, you could increase your eligibility for larger loans in the future, like an auto loan or a mortgage.

Secured credit cards offer another way to create a credit profile. With a secured card, you provide a refundable security deposit and receive a credit limit equal to that amount. Using a secured card to create smart habits like making payments on time and in full builds a credit history and demonstrates that you handle your finances well.

Borrowing money and paying it back as agreed may also help boost your credit score. A good credit score may help you get loans with a lower interest rate, saving you money over time.

Understand “good debt” vs. “bad debt” to help build wealth

One key to building your financial health is knowing the difference between good and bad debt.

Bad debt

Some types of debt might harm your financial situation if they carry high interest rates or fees.

For instance, payday loans, which are short-term loans with high interest rates, will not improve your credit score and could be costly. Higher-interest credit cards may turn into bad debt if you are unable to pay at least your minimum monthly payment.

Good debt

There are many types of good debt that may open possibilities for future income or an increase in value of something you own.

Most people take out a mortgage to buy a home. A mortgage might be considered good debt, because real estate may increase in value over time. If your home becomes worth more than the amount you owe on your mortgage, you have gained equity, which might boost your net worth. 

In addition, as you pay down your mortgage and build equity in your home, you may be able to take out a loan based on that equity to cover big expenses. There are different types of home equity loans available, including a traditional home equity loan and a home equity line of credit (HELOC).

Home equity loans typically have different options for borrowing. For example, Discover® offers lump-sum home equity options (2nd Lien) between $35,000 and $300,000.

Loans to consolidate debt may be another type of good debt, because they could help you better manage your debt load. A personal loan to consolidate higher-interest credit card debt could potentially lower your monthly payments and save you money in interest over time. Plus, you’ll have a set regular monthly payment, which benefits your budget.

When your monthly payments are lower, you might find you have extra money to make contributions to an online savings account. Some high-yield online savings accounts, like those at Discover, do not have a monthly fee or require a minimum deposit.

Explore how borrowing might increase your home’s value

When you own a home, it is important to protect your investment. Over time, you may have unexpected repairs or want to renovate or make improvements. Some improvements may increase the value of your home.

For instance, exterior improvement projects, like replacing your roof or installing new, energy-efficient windows, might provide a return on investment through energy savings. Interior projects, such as remodeling kitchens and bathrooms, may also add value.

There are several options available to finance home improvements. One good method might be to save money before a home project. Depending on the size of your project, you could also consider a personal loan or a home equity loan, either of which might cost less in interest than using a credit card.

Borrow for education as an investment in your future 

Student loans may also be a smart way to invest in your future and build wealth. They may be used to help pay for college, graduate school, or job training. Advanced education might help secure your future by expanding your job prospects and your lifetime income potential.

In general, people who have college degrees tend to be employed more and earn higher wages than those with high school degrees. But not all degrees are guaranteed to bring wealth. It can be complicated to balance a personal desire to study a chosen subject with the financial payoff of a college degree. Students might also want to consider using financial aid, scholarships, and loan programs to cover tuition and other education-related expenses.

Consider a personal loan to improve your financial health

You’ll come across a lot of borrowing options, and applying for a loan or credit can be easy.

That’s why it’s important to think about what kind of debt might work best for you before you apply. For example, you’ll want to understand details like credit limits, annual percentage rate (APR), and fees. 

After reviewing your options, you might find that a personal loan is the right choice. Whether saving money by consolidating debt from higher-interest credit cards or helping to pay for an important purchase or home renovation, a personal loan might be easier to budget for, with one set regular monthly payment. 

Whatever your financial goals are, keep in mind that the right mix of borrowing and saving might help you achieve them. Over three million people have reached their goals with Discover®Personal Loans.

To explore how a Discover personal loan might help you plan for your financial future, start by figuring out how much you need to borrow and what monthly payment you can afford. Our personal loan calculator can help you estimate monthly payments. There’s no commitment and it won’t affect your credit score.*

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*After you check your rate, if you move forward with an application for a new Discover personal loan, you will need to consent to a hard credit inquiry that will appear on your credit report.