If you grew up in a somewhat conservative household, you probably heard time and time again how dangerous debt is and how scary it can be. You might then also have these ideas reinforced by financial content creators like Dave Ramsey and his team at Ramsey Solutions celebrating guests and callers for achieving debt-free status and chastising those who continue to be disillusioned by how serious their indebtedness has become.
While there’s wisdom in approaching debt with caution, not all debt is created equal. In fact, some types of debt can actually work as wealth-building tools when used strategically and responsibly. Self-liquidating debt represents one of these more nuanced approaches to leverage that often gets overlooked in black-and-white conversations about borrowing.
So what exactly is self-liquidating debt? At its core, self-liquidating debt refers to borrowed money that is used to acquire assets or fund activities that generate enough income to pay off the principal and interest of the loan over its lifetime. Unlike consumer debt that primarily funds consumption (like credit cards used for dining out or vacation expenses), self-liquidating debt is designed to eventually pay for itself through the cash flows it helps create.
This concept represents a fundamental shift in how we might think about borrowing. Rather than viewing debt solely as a burden that drains resources, self-liquidating debt can function as a strategic financial instrument that, when deployed thoughtfully, creates value that exceeds its cost. It’s the difference between borrowing that makes you poorer over time versus borrowing that can potentially make you wealthier.
Good vs bad debt
While the popularity of podcasts and YouTube shows like The Ramsey Show and Financial Audit with Caleb Hammer highlights a growing awareness of debt issues, it also reveals widespread misunderstandings about the use of debt instruments among average consumers. Both shows aim to dissect individuals’ financial missteps and offer guidance on overcoming often overwhelming debt burdens. However, they diverge significantly in their philosophies and advice.
Dave Ramsey, whose financial counsel is deeply rooted in his religious beliefs, frequently cites Proverbs 22:7: “The borrower is slave to the lender.” He maintains a stringent zero-tolerance policy on debt, advocating that all transactions—personal or business—should be conducted in cash. If cash isn’t sufficient, Ramsey argues, one simply cannot afford the purchase. For many, especially those struggling with financial discipline, this debt-averse approach may be prudent. However, it’s important to recognise that not all debt is inherently detrimental; when used judiciously, debt can be a powerful tool for financial growth.
In contrast, Caleb Hammer adopts a more nuanced perspective. He distinguishes between “good” and “bad” debt, emphasising that the key lies in understanding and managing debt responsibly. Hammer is transparent about his own financial journey, having once been burdened with substantial debt, including private student loans and credit card balances. Through diligent effort, he transformed his financial situation, achieving a positive net worth and leveraging debt strategically to build wealth.
Hammer’s approach resonates with many because it acknowledges the complexities of modern financial life. He doesn’t categorically condemn all debt but instead encourages individuals to assess the purpose and potential return on investment of their borrowing. This perspective empowers people to make informed decisions, distinguishing between debt that can facilitate growth and debt that may lead to financial strain. The fundamental difference between Ramsey’s and Hammer’s philosophies lies in their treatment of debt. Ramsey views all debt as a liability to be eliminated, while Hammer sees it as a tool that, when used wisely, can contribute to financial advancement. Developing the discernment to differentiate between good and bad debt is a skill that requires education and experience but is invaluable for anyone serious about achieving financial stability.
How does self liquidating debt work?
Self-liquidating debt is a financial strategy where the borrowed funds are used to acquire an asset that generates income sufficient to repay the debt over time. This approach contrasts with traditional debt, where repayment relies on the borrower’s external income sources.
Consider a scenario where you purchase a rental property using a mortgage. If the rental income covers the mortgage payments, property taxes, and maintenance costs, the property effectively pays for itself. Over time, as the mortgage is paid down, you build equity in the property, and any appreciation in its value further enhances your investment. This is a classic example of self-liquidating debt, where the asset’s income stream services the debt incurred to acquire it.
In contrast, purchasing a personal residence with a mortgage, where you live in the home and make payments from your salary, does not constitute self-liquidating debt. Here, the property does not generate income to offset the debt; instead, it requires ongoing personal financial input to meet the loan obligations.
The key distinction lies in whether the acquired asset produces income that can service the debt. Self-liquidating debt leverages the asset’s revenue-generating potential to repay the loan, reducing reliance on personal income and potentially accelerating wealth accumulation.
This strategy is not limited to real estate. Businesses often utilise self-liquidating loans to finance inventory purchases, where the sale of goods generates revenue to repay the loan. Similarly, equipment financing can be structured so that the income produced by the equipment covers the loan payments.
By aligning debt obligations with income-generating assets, self-liquidating debt offers a sustainable approach to financing that can enhance financial stability and growth. It requires careful planning and analysis to ensure that the asset’s income will reliably cover the debt service, but when executed effectively, it can be a powerful tool in wealth building.
Good debt doesn’t mean risk free
While self-liquidating debt and other forms of “good debt” can be powerful financial tools, they are by no means risk-free. Like any investment or financial strategy, leveraging debt—no matter how well-planned—comes with potential pitfalls.
For starters, projected revenue, whether from property rentals or new business ventures, is never guaranteed. Buying a screen-printing machine doesn’t ensure that customers will come knocking. The same applies to property investment: even with detailed spreadsheets and promising rental projections, real-world results can fall short. A dip in the rental market, high tenant turnover, or an extended vacancy period could leave you struggling to make monthly bond payments, effectively turning a well-intentioned “good” debt into a liability.
The key to mitigating this risk lies in preparation and planning. It’s not enough to understand the concept of good debt or the power of leverage—you need to know exactly how your investment will generate income, and have contingency plans in place when things don’t go according to script. This means understanding the industry, knowing your numbers, researching comparable returns, and anticipating potential setbacks.
Because without proper preparation, even good debt can quickly turn sour. Borrowing money is not a light decision, and “betting on yourself” should never mean gambling blindly. When taken seriously—with the right knowledge, data, and strategy—good debt can be one of the most powerful assets in your financial arsenal. But the moment you treat it casually, you risk turning an opportunity into a costly mistake.
