Updated on 11.26.08

Is Debt Necessary For Generating Income?

Trent Hamm

“Margie” writes in:

My husband and I are pretty frugal, but we currently carry about $25,000 in credit card debt and a personal loan. Our monthly interest is about $800 on the balances.

My husband owns his own business and has cash in hand to pay off these balances; however, he chooses to keep the money in the business because the $25,000 cash generates about $5,000 income every month– enough to pay the interest and pay about $1,200 on each one of the the personal loan and two credit cards. This way we’ll be able to pay off the balances in about six months.

I used to feel very scared about carrying so much debt, but when he explained it to me I understood that sometimes debt is necessary in order to keep generating an income (his degree is in business economics). If we were to pay off the $25,000 it would take capital out of the business and we would lose a big chunk of income-generating money. This way we’ll be debt free soon and still have the $25,000 in the business.

What are your thoughts in this scenario?

First of all, it’s worthwhile to get a bead on how bad this debt actually is. Margie reports that she and her husband are carrying about $25,000 in debt, with a monthly interest total of about $800 on that debt. That didn’t pass the smell test to me – $800 a month in interest comes out to $9,600 a year, accounting for almost a 40% interest rate.

No matter what the reason, if you hold debts that have an interest rate that’s in double digits, you should seek to lower that interest rate. There are almost always debt solutions that allow you to reduce your interest payments if you’re carrying debt at such a high level.

So, the first step is, as always, make sure that the debt instruments you’re using are good ones. If you have debt that’s being charged at a high rate, see if you can move that debt into a different loan that doesn’t have such a high rate or request a reduction in rates.

Now, on to the meat of the question. Is debt acceptable if the balance of that debt is used to generate income?

If you’re looking at a guaranteed income, then the question is really whether the interest on the debt is lower than the income generated by the money. So, if you had a completely guaranteed method to return 10% on your money and you could borrow money at 5%, then this is a very sensible deal.

The problem is that there are no guarantees in life or in investments. Virtually every time you borrow money, you’re adding to your risk.

Sometimes that risk is worthwhile. If you need a car to get back and forth to work and you have no car, then a car loan is probably worth it. If you need an education to further your personal goals, then a student loan may be worth it.

The general question that’s really being asked here is whether a business loan is worth the risk. Certainly, a well-planned business (that’s structured independently of your personal finances, of course) may need to borrow money in order to get the business started.

However, the situation as Margie describes it appears to be a loan to the business out of their personal finances. While that can be fine, the loan is clearly having a very painful effect on their personal financial situation.

No matter how secure the business, funding that business via a high interest personal debt is not a good way to go. The risk simply isn’t worth it – if the business does not succeed, you will quite likely be left in a very sticky situation.

My advice to Margie and her husband is simple: put a lot of effort into restructuring your personal debt. See if you can reduce the interest rate on that debt and get it down to something manageable. Otherwise, you’re putting your personal finances at a very steep risk in order to sustain your business – which is never a guaranteed proposition.

If you’re just getting started and looking to start a business, never fund it via your personal finances if you have to take out high-interest personal debt to do it. That’s an extremely dangerous situation to put yourself in. Instead, seek business financing or wait until you can fund the business in a safe manner.

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  1. Jillian says:

    Am I missing something here? Im not getting how the $25K generates $5000 a month in income, thats a 20% monthly return. Unless he’s a shylock.

  2. Michael says:

    The bold and the word choice makes this hard to read.

  3. Frank says:

    I don’t mean to nit-pick, but all of the bolded text almost makes it harder to read! If something needs to be emphasized, can’t it be done with a better choice of worse? If everything is bolded, how do we know what is really important?


  4. Ryan McLean says:

    I like where your head is at. I don’t agree with people who say “all debt is bad” because sometimes it is really useful. But you are talking about being smart and minimising risks while using debt effectively. That is what I am trying to do.
    I am trying to get into as less debt as possible. That is the great thing with running a blog and business online, it doesnt cost much to start…just time
    I go into debt for my time, because giving my time will make my business strong

  5. Daniel Bruns says:

    I disagree with this advice:
    “ever fund it via your personal finances if you have to take out high-interest personal debt to do it”

    Starting up a business using a Credit card to get started is much easier and faster than applying for a business loan for most people. Of course there is risk involved and you should do this with the intent of working as hard as you can to make sure it pays off, but with great risk comes great reward.

    From a personal finance point of view your advice is sound, although small business finance is much different than personal finance. You run into higher interest rates more frequently as well as much higher returns. If the business generates $5000 each month, and they are being charged $800 in interest each month, it is a no-brainer to keep the $25,000 in the business and pay off their loans over time with the money the business is generating.

  6. RedMolly says:

    Is the $800 really interest, or actually minimum payments? That $800 seems crazy steep.

  7. Kevin says:

    Not only does the interest on the loan not pass the “smell test”, neither does making $5,000 a month on $25,000 of cash. That’s 20% a month, 240% annual return.

    Can you share what business he’s in so I can get in on that action?

  8. Susy says:

    I agree! Mr Chiot’s and I own a business and we saved up enough to buy all of our equipment and run our business without going in to debt. We even have a business emergency fund to cover business expenses in case we have a rough year.

    I don’t think business finances are really no different than personal ones.

  9. Brad says:

    This article smells weird in general. I can’t see her story checking out.

  10. First, having $25,000 unsecured personal debt is not “pretty frugal.” Second, I know of no business that can generate an extra $5000 monthly income just by keeping $25,000 cash in the business. Sounds like hubby is blowing smoke up wife’s you know what. That money either isn’t actually there or hubby is clueless about how his business actually operates.

  11. Krista says:

    I’m going to have to agree with everyone else on this one: no part of her scenario makes sense. In fact, it sounds like her husband is being very dishonest with her.

    I think Margie should consider taking a personal finance course (NOT from her husband) and then taking a closer look at both their personal and his business books.

  12. steve says:

    If the 5000 per month includes his labor, and the 25000 is capital enabling existence of the business, then those figures sound like they could be fine. $800 interest is absurd. That is very likely a figure for the minimum payment on the credit card, plus the monthly figure for the personal loan.

  13. With all due respect to the previous commenters, there are plenty of businesses that can generate 20% return in a month – especially on a low amount like $25,000.
    Just as an example an auto dealership may be able to purchase a vehicle at a wholesale auction for $25,000 and sell that vehicle for $30,000. Not taking into account the obvious other costs of completing this transaction, there is your 20% return inside one month.
    In fact, this process could be completed more than one time inside of one month, making the total monthly return even higher.
    If you have the cash to complete this, great. If not, borrowing money to make money is how businesses grow.
    Don’t believe me, just look at how much corporations make in return for the interest they pay you to buy their bonds.

  14. steve says:

    if it’s really going to be paid off in 6 months, i’d leave it as it is.

  15. LC says:

    This is exactly what leverage is. Of course we know how leverage can be a risky two edge sword. But I can’t imagine a scenario where credit cards would ever be useful. They do not offer balances sufficient nor interest rates affordable. I would say that it is very smart to borrow money at 7% for a company that generates 15%, because you are not even using your own money. Just like buying a house — you keep the profit, and the bank took the risk.

  16. I think this guy is lying to wifey. I want to know exactly how that debt is “generating income”.

    This guy’s business and personal finances could be in danger for all we know; maybe he wants to keep it under wraps by pretending he’s in complete control?

    I own a small business. Guess what, if you can generate income just by keeping money in the company, you can generate income without debt.

    This definitely doesn’t smell right.

  17. Kim says:

    It’s hard to get past Margi’s first sentence in which she claims that she has $25,000 in CC debt and considers herself “pretty frugal”.

  18. Lurker Carl says:

    Everything about Margie’s story defies logic unless hubby is a loan shark or bookie.

  19. cv says:

    The thing I find troubling about this story isn’t so much the numbers themselves, which I agree are odd, but the way she says “he chooses to keep the money in the business” and “I used to feel very scared about carrying so much debt, but when he explained it to me…” It sounds like she’s really in the dark about their finances and the finances of the business. It works for a lot of couples to have one person handle most of the finances, but the fact that she’s writing in to the Simple Dollar means that she’s not entirely comfortable with the situation. If what she says is all true the debt issue will disappear in a few months, but I think she and her husband need to work on their communication about money. Once they’ve paid off their debt, what will they be doing with the income that had been going to debt? Reinvest it in the business? Save for retirement? How risky is this business that can generate a 20% return in a month? Does that mean they need a large emergency fund? She should understand and have a say in these decisions, not just have her husband explain to her whatever he chooses to do.

  20. moneyclip says:

    I would simply rest better knowing I was debt free especially in the state of the current global economy. Nothing is guaranteed and being out of debt completely certainly is better than being in debt, no matter the reason.

  21. Jacinta says:

    None of these numbers make sense. If we were to assume that the interest amounts were right, then we have: income: $5000. interest: $800 difference: $4200. But she then says that leaves “about $1,200 on each one of the the personal loan and two credit cards.” 1200* 3 = $3600, so where’s the missing $600 going? The only number that does make sense is that if these parts are true they will have paid off $25,000 in 6 months.

    If the debt is instead $250,000 then for $800 in repayments they’d be paying an average interest rate of 3.8%; for credit card debt this seems really low. But it would mean that the $5,000 a month in interest would only require the investment to be making 24% p.a. which is probably manageable. Of course, this won’t be paid off in 6 months time.

  22. RDS at Smart Financial Values says:

    I don’t know enough about the business in question to comment on the details of this story, but in general I agree that debt can be useful. While I don’t think that there is such a thing as good debt, there is certainly bad debt and less bad debt. Less bad debt is debt that helps you start or grow your business, buy a home, or purchase a car. In a perfect world, we would all be debt free. However, given that most of us don’t have enormous piles of money sitting around, in the right circumstances debt can be useful.

    One of the only stories I have ever heard about useful credit card debt was about the athletic apparel company Under Armor. Under Armor was started by a young man and financed heavily by credit card debt. Its a risky strategy, but payed off in this case. So, if your credit card debt is helping you start a world renowned company then it is probably less bad debt. Otherwise, there are very few excuses for running a balance on your cards.

  23. Sarah says:

    I agree with the posters above–is her husband dealing in the white horse?

  24. prodgod says:

    Actually, I have converted nearly ALL of my debt to credit cards ($54k), with the exception of mortgage. Why pay the higher rates on my business loans when I can now carry balances of 0% for 12-18 months on each card? This way, 100% of my monthly payments go to principle, which allows me to make minimum payments and build interest-earning savings. Before each promo rate expires, I transfer the balance to another 0% card. Then the old card offers me another 0% rate to come back, which I use for the next card in line with a rate about to reset. I’ll have the debt paid off sooner this way.

    Yes, there are fees with each transfer, but they are substantially lower than what even a low interest rate would be.

    If you have good credit, credit cards can be a useful financial tool. And for the record, this has not seemed to affect my rating.

  25. steve says:

    Anyone who is carrying significant debt on credit cards, even at low interest rates, might want to be aware of what has recently happened to me on two credit card accounts. In the last two months, Discover and Chase have changed my minimum payments from the former 2% to a new minimum of 4% and 5% (respectively) of the outstanding balance. If you are carrying significant debt on your cards right now and paying the minimums, it would be wise to plan for the likelihood of having to come up with an extra 2-3% of your outstanding balances every month to stay in their good graces.

    I don’t know if they are doing this across the board, or because I have been carrying balances at a low rate and don’t make purchases on these cards. I suspect that plays into it. If you are carrying significant balances, it might be worth it to make a couple of small charges on those accounts (like 20 dollars or so), on the chance that the charges that their screening system might not see you as an inactive account they’d like to “hurry off” of their books. Be aware that if you do, you are carrying those charges at the going rate for purchases until the card is paid off, though.

  26. Dana says:

    I read her as saying that the $25,000 was in BOTH credit card debt AND the personal loan. Whatever the bank might be charging in CC interest, someone who tenders a personal loan is not governed by consumer laws and can charge whatever interest rate they like.

    Their monthly payment between two credit cards and a personal loan adds up to $3200. Ouch. But if they’re plugging away at these to pay them off in six months, that’s pretty good. I wish I had three grand a month to throw at my debt.

    I wouldn’t say they’re not being frugal *now*, even with the balances. For all we know these were run up a few years ago and this couple has turned over a new leaf since then.

    And we can’t say he’s scamming if we don’t know what he does for a living.

  27. Shymom says:

    I read it as 25K on credit card plus and undisclosed amount on a personal loan. As we don’t know what the amount is on the loan there is no way to accurately figure out what the interest rate is.

  28. Rather than focus on whether or not this story and these numbers make sense, I will just for arguments sake (to answer Margie’s question), take them to be true.

    If this 25,000 can generate 5,000/month, then that is 60,000 per year. That beats out 9,600 per year by over 50,000. So this is “very good” debt.

    And if they can pay their debt off in six months as Margie claims, then I don’t think that the debt is (or will be for long) having an adverse effect on their personal finance situation.

    I know a lot of people who WISH they could say they would be able to pay off their debt in 6 months.

    And also, if they have the 25,000 cash on hand… then the 25,000 debt (which they could pay off if need be) is NO RISK.

    But this is of course, assuming that what she claims is true. If so, then they are doing the right thing.

  29. Cathy says:

    The first thought that came to my head was Margie’s husband isn’t being honest about his business’ finances.

  30. Generally, the best option is always to go with minimal to no debt. There are really no sure fire, can’t miss ventures, and when they misfire the lender still wants his money.

    Best Wishes,

  31. LC says:

    The worst risk in credit card debt is that they can change any of the terms with just one 15 day written notice. Interest rate, drifting payment date, double billing cyle — you are really asking for it when you deal with a credit card company.

  32. sbt says:

    I don’t like the idea of financing the business with personal debt.

    My husband and I are part owners in a business getting off the ground. We chose to structure the business as an LLC to help protect our personal assets. We were able to get a business loan at only 5% with some state new business loan incentive program. We chose to do that rather than sell our mutual funds and pay cash, since right now they are worth about half what we have in them. hoping to get the funds back up closer to what we paid for them before we have to cash them in. Because we are frugal, we were in a good position to get the business loan. Yes, of course, should the business fold, we will be personally liable to repay the loans, but we want to keep the business books and personal books clearly separated. This is important when you have a corporation or partnership.

    I suspect that the wife above is not clear about what exactly is happening. I suggest that she and her husband have a very good talk, and make sure that they review the business finances together on a regular basis. I also liked the suggestion above that she learn more about personal finance on her own.

  33. SteveJ says:

    It seems to me that if you can show a history of earning $5000 off of $25000, then any bank in town will be thrilled to have your business and offer you a reasonable business loan.

  34. Armen says:

    I financed almost all my startup expenses except the cars by my personal credit cards. If I didn’t, I wouldn’t have equipment and advertising which makes the business running. It is very common that those who start a business first use their credit cards until they are ready to create a corporate credit and little by little move everything to corporate credit card. Otherwise, how else? Even if you have cash it’s more risky to put it in business, in case it fails, you can’t get it back as opposed to unsecured debt.

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