Productive versus destructive leverage
Which debt is worth having?
3 minute read
Productive leverage borrows at a cost below the return it produces, against something that earns or holds value, with the payment comfortably covered and a way out if it does not work.
Destructive leverage borrows for consumption or for things that lose value, at rates above any return, with payments that strain cash flow, on a bet that only works if nothing goes wrong.
The label is never on the loan type. The same HELOC can be either, depending on what you do with the money and whether the payment is covered.
Example
A 7% loan against a property that produces a 12% cash-on-cash return is productive. A 24% card balance from a vacation is destructive. Same tool, opposite outcomes.
Why this matters
This test is the difference between using debt on purpose and being used by it.
What to do with this
- For any new debt, answer three things: what does it cost, what does it produce, and what happens if the income stops.
- If you cannot answer the second one with a number, treat it as consumption.
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