Is credit a good thing or bad thing?

Well, it all depends on your perspective.

When used correctly, credit can supercharge your life and help you level up financially in a shorter time than you would have if you relied on savings alone. That’s why Dale Carnegie, in his book, “The Gospel of Wealth,” wrote that debt could be a powerful force for good if used productively.

Now, the trouble with debt is that, just like any other financial tool out there, it has been misused by lenders and borrowers alike, leading its use to be largely villainized by society. Make no mistake, in the wrong applications, debt can be a form of bondage. That’s why in some cultures, its use is forbidden and why some individuals have mortgage payoff parties instead of retirement savings celebrations.

Make no mistake, however, when used prudently, credit can boost your earnings ability, enable you to acquire appreciable or income-producing assets, and help keep you from going broke when life throws you a curveball bigger than your savings account.

Even so, a Scottish historian and author, Niall Ferguson, wrote, “credit is like a looking glass. Once cracked, it can never be the same again, and the more we use it, the more fragile it becomes…”

Indeed, these perspectives from Carnegie and Ferguson show how on the one hand, the wise use of credit can dramatically enhance your current financial situation. On the other hand, debt can leave your finances in a precarious position when not managed properly.

Certainly, much has been written about the trouble with credit and how too much debt can be a trap. Before we discuss the drawbacks of credit, let’s take a look at why you would want to use debt to lever up your current financial situation.

Why Credit Can Be a Force for Good

Credit as a Force Multiplier

When used the right way, credit can be a force multiplier. It can help you accomplish things in your life that you otherwise may not have been able to do on your own financially.

Now, the term force multiplier is often used in the military to describe a factor, such as better positioning or equipment, that can increase a unit’s combat potential, allowing it to fight on a par with a more significant fighting force.

For instance, in World War II the development and use of radar technology arguably changed the course of the war in favor of the Allies. As you’ll recall, radar is a detection system that uses radio waves to determine the location, speed, and direction of objects.

Now, radar served as a force multiplier for the Allies by providing them with a significant advantage in air and naval combat. With radar, the Allies could detect incoming enemy aircraft and ships at a much greater distance than the enemy could detect them. This tool allowed the Allies to prepare their defenses and launch counterattacks more efficiently and accurately.

For example, radar played a critical role in the Battle of Britain, in which the Royal Air Force (RAF) used radar to detect incoming German aircraft and direct their own fighters to intercept them. Using radar allowed the RAF to defend against the German bombing campaign more effectively and played a crucial role in their eventual victory.

So, from this perspective, credit can act as a force multiplier by taking the financial resources you have today and amplifying them to achieve a broader victory in your life.

How so?

Well, the first way it can benefit you is by enhancing your future earnings ability by allowing you to borrow money in the present so that you can improve your skills and get credentials that can help you break into a new field or raise you to a higher earnings level in your current role. And while the topic of college education, and more specifically college debt, is hotly debated today, the statistics still argue in favor of a college degree.

Now, according to data from the Bureau of Labor Statistics’ most recent Occupational Outlook Handbook, the data show that those jobs with the fastest industry growth rates and median pay of at least $100,000 all require a college degree. Indeed, according to the same government data, there is a growing earnings gap between individuals holding a college degree and those without.

For example, government data show that the average 25-year-old full-time worker with a bachelor’s degree made a median annual wage of around $55,000, compared with $30,000 for full-time workers of the same age group with just a high school diploma. And when we look at the earnings gap over a lifetime, it continues to increase. Here again a study from the Department of Education shows that an individual with a high school diploma is likely to earn a median income of around $1.9 million over their lifetime.

However, an individual with a bachelor’s degree could earn $3.4 million over their lifetime, while a top-earning professional degree could bring in nearly $6.5 million. So, then, even if we assume that it costs an individual $160,000 to obtain and pay off their debt over ten years, the costs associated with the college debt would still net an extra $1.3 million or a multiplier of eight times of what a non-college graduate could earn over their lifetime.

So, then, from this perspective, we can say that credit can act as a force multiplier to enhance an individual’s inherent knowledge and increase their earnings power.

A Lever for Wealth Building

Another way that credit can dramatically change your financial situation is by giving you leverage to use a little bit of money to create a lot of wealth. Now, for many individuals, purchasing a home is one way to create wealth. Certainly, arguments have been and continue to be made for and against the wealth-building attributes of home ownership. Even so, the long-term benefits become evident once you look past the short-term costs of home ownership versus renting.

Now, one way homeownership builds wealth is through the appreciation of the value of your home over time. Historically, home values have tended to appreciate over the long term, sometimes resulting in significant wealth gains to homeowners. And while you may be only putting down five- ten-, or twenty-percent towards the purchase of a home, you gain access to the full value of the appreciated equity in your home over time when you borrow against or sell it.

What’s more, homeownership can help you build wealth through the process of forced savings. That’s because the longer you make mortgage payments, the more principal you pay down, which is essentially putting money into a savings account each month, assuming home values remain stable. And this approach can help you build wealth over time, even if the cost of homeownership is slightly higher in the short term than that of renting.

Another way that credit can help turn a little bit of money into a lot of money is by starting a business. Now, the internet is filled with stories of individuals who borrowed money to achieve wildly successful outcomes. And one rags-to-riches entrepreneur who used debt to start their business is John Paul DeJoria, the co-founder of John Paul Mitchell Systems, the haircare company.

Now, DeJoria was raised in a low-income family and faced financial difficulties throughout his life. In fact, in 1980, when he decided to start John Paul Mitchell Systems with his partner, Paul Mitchell, DeJoria was homeless and living out of his car. Even so, he borrowed $700 to launch the company and personally went door-to-door selling their first hair care products. And through perseverance and hard work, DeJoria managed to grow the business into a multi-billion dollar empire, making him one of the most successful entrepreneurs in the world.

Help You Stay Solvent

A final way that credit can be a valuable tool in your financial toolbox is that it can help you stay solvent even when you’re short on cash. This point is especially salient should you have an unexpected home or auto emergency, an unforeseen medical expense, or suddenly find yourself without a job.

Now, make no mistake, when it comes down to it, an emergency fund or a solid cash management strategy is a prudent way to help mitigate these financial risks.

Even so, a time likely will come when using credit can help you stay solvent enough to keep your priorities straight and stay on track to your journey to financial independence. That’s because if you’re facing an unexpected one-time big-ticket expense, such as a large medical bill or a significant home repair, instead of drawing down on your savings or liquidating your investments, you can use credit to cover the expense to preserve your financial security.

Indeed, by using credit responsibly, you can, over time, spread out the cost of a large one-time expense. And why not just use cash savings to pay down the debt? Well, if you draw down your cash reserves too much, you risk putting yourself in a position where you’d be unable to handle uneven cash flow situations or potentially limit your optionality when other unforeseen expenses come your way as they inevitably do.

What’s more, using credit to cover unexpected expenses can also help you achieve financial freedom in the long term. Now, while this may sound counterintuitive, this works because by avoiding the need to liquidate your investments or tap into your savings, you can preserve your wealth and allow your money to compound over time.

So, when it comes down to it, credit can be a force for good when it’s used the right way. Indeed, credit can act as a force multiplier when it comes to your earnings ability, and it can serve as a lever to help acquire assets that might build long-term wealth and a means to help buy time and stay solvent so you can keep fighting in the game.

Give Your Credit a Good Purpose

Now, when it comes to the prudent use of credit, what trips up a lot of individuals is not necessarily gaining access to credit but needing a clearly defined purpose for how they’ll use the credit itself. At that point, credit becomes a problem because, without a clearly defined purpose for your money, you may end up relying on credit to live someone else’s money script., or, as Will Rogers puts it, spending money you haven’t earned, to buy things you don’t need, to impress people you don’t like.

Indeed, this topic is essential and one we spent time on in a broader discussion about giving your money purpose in past articles. And as you’ll likely recall, giving your money purpose means knowing…

• why you work in a chosen profession
• where you are spending and what you are spending my money on
• why you are saving money for the future
• how you will feel when you can use your money to make critical life change
• that your kids won’t have debt burdens when they go to school
• that you are leaving something behind for future generations to enjoy
• that you can spend money without feeling guilty
• that no matter what happens in the economy or markets that, your financial situation is secure
• that you can help out a friend or family member when the financial need arises
• that you have the resources you need to pursue your hobbies and passions
• that you have the time to do what you want when you want
• that you have options to make life changes
• that no job or relationship will ever control your ability to live a fulfilling life
• that you can give your family life experiences that they can treasure

So, what purpose does your money have?

Take a moment to consider the values and purpose that you defined for your life. Then, think about the near- and long-term life priorities that you’ve defined for your life journey.

Now, ask yourself, “how can I use my credit as a force multiplier, leverage to acquire productive assets, or to ensure that I have an adequate last-resort backstop?”

Put differently, if you plan to use credit to amplify your future earnings potential, ask yourself if your chosen profession on vocation and the credential you’re planning to borrow for is genuinely something that aligns with your values and the purpose that you’ve defined for your life. If not, then carefully consider whether borrowing for this education goal is something you might regret if it’s not moving you closer to your intended life.

Tim Kasser, a psychologist who has written extensively on the psychological consequences of materialism and the pursuit of wealth, emphasizes the importance of aligning one’s chosen vocation with their values and life purpose. And Kasser argues that people who pursue careers solely for the sake of money and status are more likely to experience adverse psychological outcomes, such as anxiety, depression, and a lack of fulfillment.

That’s why Kasser suggests that individuals who choose a career that aligns with their values and life purpose are more likely to experience a sense of meaning and purpose in their work. This, in turn, can lead to greater intrinsic motivation, satisfaction, and overall well-being, but more importantly, a genuinely prudent use of credit.

As it relates to borrowing to acquire an asset like a home or car, here again, the question you want to ask yourself is whether the purchase you make will move you further down your path to financial independence or whether it’s simply serving as a means to satisfy someone else’s money script.

To be sure, Horstein Veblen, a prominent economist and social theorist, believed that people often engage in conspicuous consumption, or the spending of money on items solely to display wealth and social status, in order to signal their social status and impress others. In his book “The Theory of the Leisure Class,” Veblen argued that people engage in this behavior as a way of demonstrating their superiority over others in their social circles.

So before you go out and borrow to buy a new house or car, ask yourself if your motivation is based on moving you closer to your intended life purpose or simply to live someone else’s money script.

And when it comes to relying on credit as a stop-gap for emergencies, remember that cash should be your primary means for addressing one-time big-ticket spending needs.

An emergency savings fund can serve as your financial safety net, ensuring that you stay on track with your financial goals and avoid setbacks when unforeseen expenses arise. When you have this reserve in place, you’re able to cope with unexpected events, such as medical emergencies, car repairs, or job loss, without dipping into your long-term savings or incurring debt.

Either way, giving your money purpose is the first step in getting off the hedonic treadmill of mindlessly borrowing more money simply to chase after outcomes or spend it to impress others. Alternatively, it can give you the push you need to begin spending more intentionally if you’re a natural saver and worry too much about overspending.

How Much is Too Much of a Good Thing?

Now that we’ve talked about how credit can fast-track your path to financial independence and how aligning its use with your money’s purpose can help you make wise borrowing decisions, let’s take a moment to discuss why too much credit can be too much of a good thing.

Now, it’s common sense that we all need to borrow money within reason. Most, if not all, financial professionals out there argue against accessing credit, and the truth is, you likely know individuals in your own life who have had their financial plans derailed because of unmitigated borrowing and spending choices.

In fact, Suze Orman, the well-known personal finance expert, struggled with debt early in her life, which impeded her ability to achieve her financial goals. That’s because Suze grew up in a middle-class family in Chicago, and while she was always interested in finance, she didn’t have the best financial habits.

As a young adult, Suze worked as a waitress and later as a financial advisor, but she was living beyond her means and accumulating debt. At one point, she had over $20,000 in credit card debt and owed money to the IRS. Despite making a decent income, Suze struggled to make ends meet and could not save for her future.

It wasn’t until Suze hit rock bottom that she realized she needed to take control of her finances. That’s when she made a plan to pay off her debt, cut back on her spending, and start saving for her future. She even took a job as a financial advisor in California to learn more about managing money and building wealth.

Over time, Suze’s financial situation improved, and she was eventually able to achieve her financial goals. Despite her early struggles with debt, however, Suze’s experiences taught her valuable lessons about the importance of managing money wisely and avoiding the pitfalls of debt. She has since become an advocate for financial education and empowerment, helping others take control of their finances and achieve their financial goals.

Now, as you think about the possibilities that borrowed money can open up in your life, it’s easy to forget that your debt will need to be serviced. That’s why when you’re not paying attention to how much you’re borrowing or who you’re borrowing from, you could find yourself in a position where you’re earning an income simply to pay off your creditors. And when you do, it becomes a form of bondage.

This is because you could find yourself in a position where a large portion of your income is going towards paying off your debts, leaving you with little money to spend on the things you want or need. You may also find yourself needing help to make ends meet, unable to save for the future, or even struggling to pay for unexpected expenses.

Additionally, having excess debt can also limit your options and control over your life. For example, you may be unable to change jobs or start a business because you need a steady income to service your high debt load. You may also have to put off major life milestones, like buying a house or starting a f amily, because you simply cannot afford it.

The stress and anxiety that come with being in debt can also take a toll on your mental and emotional well-being. You may feel trapped and hopeless, constantly worrying about how you will make ends meet or how you will ever pay off your debts.

And, when taken together, servicing too much debt can be a form of bondage because it limits your options, control, and ability to live the life you want. It can be a constant source of stress and anxiety, leaving you feeling trapped and unable to break free.

Setting the Right Levels

So, what is an ideal amount of debt to carry? Let’s take a look at some ideal borrowing limits for key consumer debt categories, starting with your home.

Mortgage

Now, when it comes to borrowing to purchase a home, Clark Howard, author of the book,” Living Large in Lean Times,” believes that limiting your monthly mortgage payments to no more than 28% of your gross monthly income is important because it can help you avoid taking on more debt than you can comfortably afford to repay. That’s because when you take on too much mortgage debt, you risk becoming “house poor” and not having enough money to meet other financial obligations or save for the future.

In his book, Clark further explains that your mortgage payment should consider the principal and interest on your loan as well as the property taxes, insurance, and any homeowners association fees. That’s why he recommends that you calculate the total cost of owning a home before making a purchase, taking into account all of these expenses as well as any maintenance or repair costs that may arise.

For example, Howard suggests that if you earn $5,000 per month before taxes, your total monthly mortgage payment should not exceed $1,400 (28% of $5,000). If your mortgage payment is higher than this amount, he recommends that you consider finding a less expensive home or waiting until you have saved up a larger down payment to reduce your monthly payment.

Auto Loans

And when it comes to buying a new car, what’s a reasonable amount to borrow? Well, in “Your Money: The Missing Manual,” J.D. Roth recommends that you should keep your auto loan debt to a minimum and aim to pay cash for your vehicles whenever possible. However, if you need to take out an auto loan, he suggests limiting your monthly car payments to no more than 10% of your take-home pay.

Roth believes that taking on too much auto loan debt can be a financial burden and limit your ability to achieve other financial goals, such as saving for retirement or emergencies. He suggests that you should choose a used car instead of a new car, as they are often more affordable and can provide good value for your money.

Roth also recommends that you shop around for the best auto loan rates and terms before making a purchase and suggests that you should avoid dealer financing and consider getting pre-approved for an auto loan from a credit union or bank before shopping for a car.

Credit Cards

According to government data, many Americans carry a balance of at least $1,000 on their credit cards. That’s why in her best-selling personal finance book “The Money Class: How to Stand in Your Truth and Create the Future You Deserve,” Suze Orman recommends that you aim to keep your credit card debt to no more than 30% of your available credit limit.

What’s more, Suze argues that you should aim to pay off your credit card balances in full each month to avoid high-interest charges and long-term debt. In her book, Orman goes on to explain that carrying a balance on your credit card can be costly, as interest charges can quickly add up over time.

Student Loans

And finally, when it comes to student loan debt, how much should you aim to borrow for yourself or for your children? Well, in “Making the Most of Your Money Now,” Jane Bryant Quinn recommends that you should limit your total student loan debt to no more than your expected annual salary after graduation. This means that if you expect to earn $40,000 per year after graduation, you should aim to limit your total student loan debt to $40,000 or less.

Quinn emphasizes the importance of minimizing student loan debt as much as possible by exploring alternatives such as grants, scholarships, work-study programs, and part-time jobs. She also suggests that you should choose a less expensive college or university, attend community college before transferring to a four-year institution, and take advantage of programs that allow you to earn college credit while still in high school.

The Costs of Poor Debt Management

Now, as we mentioned earlier, being able to stick to a disciplined use of credit can help you avoid running afoul of common borrowing issues. That’s because when your borrowing gets out of hand, it can lead to unfavorable situations that 1) limit your optionality and creates missed opportunities and 2) creates more emotional stress and anxiety in your life.

Make no mistake, when managed wisely, credit can help you fast-track your path to financial independence by acting as a force multiplier for your earnings ability, providing you with the leverage you need to acquire appreciable assets and keeping you solvent in times of emergency.

Too Much Debt: Missed Opportunities

Even so, taking on too much debt can limit your ability to jump on financial opportunities that may come your way.

How so? Well, let me tell you about Frank.

Frank is an entrepreneur who used his stellar credit to borrow money to start a business. However, one afternoon, Frank found himself sitting at the kitchen table, sifting through a pile of bills he had accumulated from his startup. Now, Frank had always been a responsible person, but a series of unexpected events with his startup had left him struggling to keep up with his financial obligations.

And, a few weeks ago, a close friend approached Frank with a promising business opportunity. They needed a partner to help expand their thriving local storefront into a chain of stores, and they believed Frank had the skills and experience to make it a success. The potential for lucrative returns was undeniable, but the required initial investment was substantial.

Frank spent countless nights analyzing the opportunity and dreaming of the financial freedom it could bring him and his family. This opportunity could be his ticket out of debt, a way to secure a comfortable future. But as he sat down to create a detailed plan, he realized that his current debt situation made it impossible to take on the additional financial risk.

His mortgage, car loans, and credit card balances had snowballed into a mountain of debt that was suffocating his finances. The monthly payments were barely manageable, and he knew that adding another significant obligation could easily push him into a downward spiral.

Frank hesitated for days, trying to figure out a way to make it work. He considered taking on a second job, selling some assets, or even asking for a loan from family members. But deep down, he knew that none of these options would be enough to keep his head above water if the venture didn’t go as planned.

With a heavy heart, Frank picked up the phone to tell his friend that he couldn’t join them in the business venture. He could hear the disappointment in their voice, but they understood his situation and wished him well.

Now, as he sat at the kitchen table, he knew that it was time to face his financial reality head-on. He would need to develop a plan to tackle his debt, cut back on expenses, and work towards a more secure financial future. The missed opportunity served as a reminder of the importance of managing his finances responsibly and staying on top of his obligations.

Though the thought of what could have been stung, Frank understood that he must focus on overcoming his current challenges before he could chase after new opportunities. He was determined to learn from this experience and ensure that the next time an incredible opportunity came knocking, he would be ready to answer the door.

Too Much Debt: Financially Fragile

Certainly, taking on too much debt may limit your choices when lucrative financial opportunities come your way. What’s more, while credit can act as a lifeline for one-off, big-ticket purchases, borrowing too much money can leave you financially fragile and unable to bounce back if you get hit with another unexpected life event.

And that’s what happened to Maria.

Now, Maria had always been prudent with her money, living frugally and saving for the future. However, she couldn’t have anticipated the series of events that would unfold and leave her in a financially fragile position.

A few years ago, however, she decided to take the plunge and purchase her dream home, with a picturesque view and a spacious backyard for her growing family. She took out a sizable mortgage that was at the top end of her budget, but with her steady income and careful budgeting, she felt confident that she could manage the monthly payments.

Life carried on smoothly for a while, and Maria made consistent progress towards paying down her mortgage. However, unforeseen challenges began to arise. Her partner lost their job due to company downsizing, and although they actively searched for a new position, it took months for them to secure another job, leading them to burn through their emergency savings because her partner’s unemployment benefits weren’t enough to cover their share of the household expenses, leaving Maria to shoulder the burden alone.

To make matters worse, she was hit with an unexpected medical emergency that required surgery and a lengthy recovery. While her insurance covered most of the costs, she was still left with significant out-of-pocket expenses. This event also forced her to take extended leave from her job, which impacted her income further as her long-term disability only covered a portion of her regular income.

To stay afloat, Maria reluctantly turned to credit cards to cover the mounting expenses. Soon, however, the minimum payments on her credit card balances began to pile up, adding to her already strained budget.

Just when she thought things couldn’t get any worse, a leak in her home’s roof led to water damage and costly repairs. Desperate to address the issue before it worsened, she took out a home equity line of credit, hoping to pay it off once her financial situation improved.

Unfortunately, the combined weight of the mortgage, credit card debt, and the home equity line of credit left Maria struggling to keep her head above water. With each passing month, she found it harder to make ends meet, and the stress began to take a toll on her physical and mental well-being.

Maria never imagined that her pursuit of a dream home could lead to such a financially fragile position, but the combination of unforeseen challenges and mounting debt became an overwhelming burden. Nevertheless, this was her “rock bottom” moment, and now she’s focused on finding a way to overcome this difficult situation and regain control of her financial future.

The takeaway here is that while credit can be helpful, too much of a good thing can act as kryptonite, holding you back from potential opportunities or leave you financially fragile if you overstretch your borrowing budget.

That’s why it’s crucial to understand that debt isn’t always the enemy when you’re working towards financial independence. Indeed, if used wisely, credit can be a superpower, amplifying your future earning potential, providing leverage for purchasing valuable assets, and offering a safety net during tough times.

However, it’s vital to remain true to your core values and the purpose you’ve assigned to your money. Be introspective and ask yourself whether a debt-related purchase aligns with your financial goals or if it’s merely catering to someone else’s expectations. This mindfulness will help you avoid overconsumption and ensure your credit works for you, not against you.

And finally, think of managing your credit as an essential skill, much like spending and saving judiciously. Overwhelming debt can lead to lost opportunities and financial fragility in the face of life’s unpredictable events. Nevertheless, by adopting a balanced approach, you’re well on your way to crafting a stable, prosperous future—one in which you’re moving one step closer to mastering your path to financial independence.