Debt Isn’t Always a Bad Thing
For a long time, I believed debt was something to avoid at all costs. Like many, I thought being debt-free was the key to financial success. But the more I learned about how the wealthy handle their finances, the more I realized that debt itself isn’t the enemy. It’s how you use it that makes the difference.
The rich don’t fear debt—they leverage it. While most of us think of debt as something that drags us down, the wealthy see it as a tool. They use it to grow their wealth, invest in new opportunities, and, perhaps most surprising of all, lower their taxes. This isn’t about taking on reckless amounts of debt; it’s about using debt strategically, in ways that make their money work harder.
In this article, I’ll show you four ways the rich use debt to get richer and avoid taxes. These are strategies that might sound counterintuitive, but they’ve been used for decades by those who know how to make the system work for them. Let’s take a closer look.
1. Leveraging Low-Interest Loans to Invest in High-Return Assets
One of the most effective ways the rich use debt to get richer is by borrowing money at low interest rates and investing it in assets that provide higher returns. This approach is all about using leverage—borrowing money to invest more than you could with just your own capital. When done wisely, the returns on these investments can far outstrip the cost of borrowing, leading to substantial profits.
Here’s how it works: The rich secure loans at low interest rates, often through mortgages, business loans, or lines of credit, and invest that borrowed money in assets like real estate, stocks, or businesses. If the return on these investments exceeds the interest on the loan, they profit from the difference. This is essentially the same principle that drives real estate investing: using other people’s money (the bank’s) to control a large asset that appreciates over time.
Example: Suppose an investor takes out a $500,000 mortgage at a 3% interest rate to buy an investment property. Over the course of a year, the property generates a 6% return through rental income and appreciation. Here’s what that looks like in numbers:
- Loan interest cost: $500,000 x 3% = $15,000
- Return on investment: $500,000 x 6% = $30,000
- Net profit: $30,000 – $15,000 = $15,000
In this scenario, the investor uses the bank’s money to earn a profit of $15,000. That’s an additional return they wouldn’t have achieved without using debt to increase their investment.
2. Using Real Estate Equity to Unlock Tax-Free Cash
Another way the wealthy use debt to build wealth and minimize taxes is by tapping into the equity in their real estate holdings. Instead of selling properties—which would trigger capital gains taxes—they borrow against the value of their properties, allowing them to access large sums of money without having to pay taxes on it. This strategy, known as a cash-out refinance or home equity loan, allows them to use their real estate as a source of tax-free cash to fund other investments, purchases, or even their lifestyle.
How It Works
Let’s say a wealthy investor owns a property that’s significantly appreciated over the years. Instead of selling it and paying capital gains taxes, they borrow against the property’s equity. This gives them immediate access to cash, which they can then reinvest or use, while keeping the property in their portfolio to continue appreciating or generating rental income.
For example, imagine an investor owns a property initially purchased for $500,000 that has appreciated to $1 million. The equity in the property is now $500,000 ($1 million market value – $500,000 remaining mortgage balance). The investor can refinance the property, take out a loan of, say, $300,000 against the equity, and access that cash tax-free.
Why It Works
When you sell an asset, you trigger a taxable event. In the U.S., long-term capital gains on real estate can be taxed at rates between 15-20%, depending on income. But borrowing against the property doesn’t trigger any tax because it’s technically a loan, not a sale.
Here’s a simple breakdown with numbers:
- Scenario 1: If the investor sells the property outright, they’d owe capital gains taxes on the $500,000 gain. At a 20% tax rate, that would mean paying $100,000 in taxes, leaving them with $400,000.
- Scenario 2: If they borrow $300,000 against the property instead, they get access to the cash without paying taxes. They still own the property, which may continue to appreciate and generate rental income, while using the borrowed funds for other investments.
Trust Statistics
According to a Zillow report, U.S. home prices have risen by 7.4% annually on average over the past decade. For wealthy individuals with significant real estate portfolios, this appreciation creates substantial untapped equity. Instead of selling and paying hefty taxes, borrowing against this equity gives them access to capital with no immediate tax burden.
Risks and Considerations
Of course, this strategy isn’t without risk. Borrowing against your real estate increases your debt load, and if property values drop, you could owe more than the property is worth (known as being “underwater”). Additionally, you must make sure that rental income or other income streams can comfortably cover the loan repayments.
Actionable Tip
If you own a home or investment property with substantial equity, consider a cash-out refinance or home equity loan to access tax-free cash. This is a smart move for investors who need liquidity but don’t want to sell an appreciating asset. Just ensure the terms of the loan are favorable, and have a clear plan for how you’ll use the funds.
By borrowing against real estate, the rich unlock access to cash without selling their assets or triggering a tax event, giving them more flexibility to invest in new opportunities and grow their wealth.
Why It Works
This strategy works when the return on the investment exceeds the cost of borrowing. In recent years, low interest rates have made this approach especially appealing, allowing wealthy individuals to borrow cheaply and funnel that money into high-performing investments like real estate or the stock market. Historically, real estate in the U.S. has appreciated at an average rate of about 3-5% per year, while the stock market has averaged annual returns of 7-10%. When you’re borrowing at a rate lower than these average returns, the math starts to work in your favor.
According to Federal Reserve data, the average interest rate on a 30-year fixed mortgage was around 3.1% in 2021, while the S&P 500 had an annual return of 26.9% that same year. This gap between borrowing costs and potential returns is where the wealthy thrive.
Risks and Considerations
Of course, leverage isn’t without risk. If the return on investment doesn’t exceed the cost of borrowing, or if the value of the asset declines (as can happen with real estate or stocks), you could end up losing money. But the wealthy mitigate these risks by carefully selecting investments that are likely to outperform the cost of their debt.
Actionable Tip
If you’re considering leveraging debt to invest, make sure the interest rate on your loan is lower than the expected return on your investment. Focus on relatively stable, income-producing assets like real estate or diversified stock portfolios, and avoid high-risk ventures unless you’re prepared for potential losses.
By understanding the power of low-interest loans, the rich turn what most of us fear—debt—into a powerful engine for building wealth.
3. Tax Deductibility of Loan Interest
One of the most powerful ways the wealthy use debt to their advantage is by taking advantage of the tax deductibility of loan interest. This strategy allows them to reduce their taxable income, effectively lowering their overall tax bill while using borrowed money to invest or grow their wealth. The rich strategically use loans where the interest is tax-deductible, turning debt into a tax-saving tool.
How It Works
Certain types of loans, particularly those used for business or investment purposes, allow the borrower to deduct the interest paid from their taxable income. This means that not only are the wealthy using debt to increase their purchasing power, but they’re also getting a tax break on the interest they pay for that debt.
One common example is the mortgage interest deduction. Homeowners can deduct interest on mortgage loans for a primary residence, reducing their taxable income. However, the wealthy often take it a step further by using loans to finance investment properties or businesses, where interest is also tax-deductible.
Here’s how the numbers might play out for an investor with a rental property:
- Let’s say the investor takes out a $1 million loan at 4% interest to buy a rental property.
- The annual interest paid on that loan would be $40,000.
- If the investor earns $150,000 in rental income, they can deduct the $40,000 in interest from their taxable income, reducing it to $110,000.
The tax benefit is particularly attractive when considering the progressive nature of income taxes. For an investor in the 35% tax bracket, this deduction would save them $14,000 in taxes (35% of $40,000), effectively lowering the cost of borrowing.
Why It Works
For wealthy individuals and businesses, large interest payments can add up quickly. By deducting these payments from their taxable income, they’re able to keep more of their earnings and lower the effective cost of borrowing. The more they borrow for investments or business expenses, the more they can save on taxes through interest deductions.
Trust Statistics
According to the IRS, mortgage interest deductions saved American homeowners more than $68 billion in 2020. While these deductions are available to anyone who qualifies, the wealthiest homeowners benefit the most, as they tend to have larger mortgages and higher interest payments. Furthermore, a report by Tax Policy Center shows that households with incomes over $100,000 receive nearly 90% of the benefits from the mortgage interest deduction.
For investors and business owners, interest deductions are just as valuable. A 2021 IRS report shows that businesses claimed over $1.2 trillion in interest deductions that year. This shows just how important this strategy is for high-net-worth individuals and companies looking to reduce taxable income while leveraging debt to invest.
Example: A real estate developer who takes out a $5 million loan at 5% interest to build an apartment complex would pay $250,000 in annual interest. If this developer earns $600,000 in rental income from the property, they could deduct the $250,000 in interest from their income, lowering their taxable income to $350,000. For someone in the 37% tax bracket, this would result in a tax savings of $92,500.
Risks and Considerations
While the tax deductibility of loan interest is a powerful tool, it’s important to remember that it only makes sense if the loan is used for investment or business purposes. Personal loans, credit card debt, and loans for non-investment purposes generally don’t qualify for interest deductions. Additionally, it’s important to ensure that the tax savings outweigh the cost of borrowing.
Actionable Tip
If you’re borrowing money for investment or business purposes, make sure you’re taking full advantage of the interest deductions available. Keep clear records of the purpose of the loan and all interest payments, and consult a tax professional to ensure you’re maximizing your tax benefits.
By utilizing the tax deductibility of loan interest, the wealthy can turn debt into a financial advantage, lowering their taxable income while simultaneously growing their investments.
4. Borrowing to Fund Lifestyle While Avoiding Capital Gains
A lesser-known but highly effective strategy used by the wealthy is borrowing against their appreciating assets—such as stocks, real estate, or businesses—to fund their lifestyle without triggering capital gains taxes. Instead of selling these assets, which would incur taxes on the profits, the rich borrow against them. This allows them to access liquidity while keeping their investments intact and growing over time.
How It Works
Let’s say a wealthy investor holds a portfolio of stocks worth $5 million, which has appreciated significantly over time. If they sell a portion of these stocks to fund a large expense—say, $500,000—they would need to pay capital gains taxes on the profits. In the U.S., long-term capital gains taxes range from 15% to 20%, depending on income levels. For high-income earners, that could mean a 20% tax on the profits.
Instead of selling the stocks, the investor could take out a securities-backed loan or a margin loan against their stock portfolio. This allows them to borrow up to 50% of the value of their stock portfolio at a low interest rate, typically around 2-5%, without selling a single share. Here’s what that looks like with numbers:
- Scenario 1: Selling $500,000 worth of stock triggers a $100,000 capital gains tax if the original cost basis is $0 (100% profit). This means the investor only gets to keep $400,000 after taxes.
- Scenario 2: Borrowing $500,000 against their $5 million stock portfolio incurs no tax, and they get the full $500,000 to spend or invest. They’ll pay interest on the loan, say at 3%, which amounts to just $15,000 per year—far less than the $100,000 capital gains tax in Scenario 1.
Why It Works
Borrowing against appreciating assets, rather than selling them, allows the rich to sidestep capital gains taxes while keeping their investments in the market. These assets continue to grow in value, often at a rate much higher than the interest on the loan. In essence, they maintain control of their wealth while also accessing liquid cash when needed.
Additionally, this strategy works particularly well in environments where interest rates are low, as the cost of borrowing is significantly reduced. For example, during the past decade of low-interest rates, borrowing against stock portfolios or real estate became a no-brainer for many wealthy individuals.
Trust Statistics
According to a report by UBS, the use of securities-backed loans among the wealthy has grown by over 40% in the last five years, as investors look for ways to unlock liquidity without selling their appreciating assets. Another study by Bank of America found that high-net-worth clients are increasingly using margin loans to access capital, with loans totaling over $45 billion in 2021 alone.
Example: Consider a tech entrepreneur with $10 million in stock options. If they need $1 million to purchase a new home, selling those shares would result in a $200,000 capital gains tax. Instead, by taking out a margin loan at 3% interest, they can borrow the $1 million and pay just $30,000 per year in interest, avoiding the tax altogether and allowing their stock portfolio to continue growing.
Risks and Considerations
While borrowing against assets can provide liquidity without the tax hit, it’s not without risks. If the value of the underlying asset drops significantly, the lender may require additional collateral, or worse, sell off the assets to repay the loan. This is particularly true with margin loans, where the lender can liquidate the borrower’s assets if the loan-to-value ratio gets too high due to a market downturn. It’s critical to ensure that the underlying assets are stable and that you have a contingency plan in case of a market drop.
Actionable Tip
If you own appreciating assets like stocks or real estate, consider borrowing against them to fund large expenses rather than selling and triggering capital gains taxes. Speak with your financial advisor or brokerage about options for a securities-backed line of credit or margin loan. Ensure that you understand the terms, interest rates, and risks involved, particularly if the market turns volatile.
By borrowing against assets to fund their lifestyle, the rich effectively avoid capital gains taxes, keep their wealth invested, and still enjoy liquidity when needed—one more example of how they use debt as a strategic tool to build wealth while minimizing taxes.
Conclusion: Using Debt Wisely to Build Wealth
Debt isn’t inherently bad—what matters is how you use it. While many see debt as a burden, the wealthy view it as a powerful tool to unlock opportunities, grow their investments, and minimize their tax liabilities. By leveraging low-interest loans to invest in high-return assets, tapping into real estate equity without triggering taxes, taking advantage of interest deductions, and borrowing against assets instead of selling, the rich have learned to make debt work for them rather than against them.
The key takeaway here is that debt, when used strategically, can be a pathway to wealth building, not just a financial drain. But these strategies require discipline, careful planning, and a solid understanding of how to balance risk and reward. Used unwisely, debt can quickly spiral out of control. Used smartly, however, it can accelerate wealth growth in ways that many of us never thought possible.
The rich aren’t afraid of debt—they embrace it when it helps them grow their wealth while keeping more of their hard-earned money. For the rest of us, understanding these strategies can provide new ways to think about debt and how to use it effectively. It’s not about going into debt recklessly; it’s about seeing debt as a financial lever, one that, when pulled wisely, can propel you closer to your financial goals.
