Updated: 4 days ago
Using debt to create passive income is one way to accelerate your path to financial independence.
The concept is fairly straightforward. Borrow money (i.e. debt), and then use that borrowed money to make you more money. Sounds nice, doesn't it? You'll create money out of thin air, use that money to generate cash, and spend your time how you choose.
Well, that's exactly what we're going to discuss.
Disclaimer: These approaches I've tested and used myself, but be warned. I am not a financial advisor and I do not work in finance or accounting. Follow these tactics at your own risk.
In practice, there are some risks. When you borrow money, you have to pay it back. If something happens to the money that you borrowed and you can't pay it back, you're in trouble. You'll be hit with penalty fees, collateralized assets may get taken from you, and you may even run into bankruptcy if those debts are large enough.
The approaches I use and will explain in this post are certainly not entirely risk-free. But I believe them to be some of the lowest risk approaches one can take when using debt to build wealth. I’ve been using debt to create passive income which now covers roughly half of my annual expenses using debt alone!
And I'm not alone. A report using data from the Federal Reserve shows that the top 1% in the US, in terms of household wealth, have disproportionately more debt than the lower classes, and other articles have investigated the Buy, Borrow, Die approaches some wealthy individuals take advantage of when using debt to build wealth and fuel passive income.
Wealthy individuals often view debt differently than the poor and middle class. Debt can be a tool for building wealth. So even though we aren't swimming in wealth yet, we can still adopt the same mentality to building wealth!
Where I find debt for passive income
I’ve been using three sources of debt for passive income, but they currently all rely on the same source of passive income - staking stablecoins.
I explain in more detail the process of staking stablecoins. But I'll start by pointing out the sources of debt I access to generate passive income.
1. Credit Card Loans
This is one of my favorite tricks for generating passive income from debt, because it does not require previously saved cash on hand to start.
Banks like Chase and Citi have a credit service whereby they allow you to use your available credit card credit as a loan. This loan shows up in your account just like you used your credit card, and it is treated as such by credit rating bureaus.
However, the loan has one significant advantage that I leverage for passive income generation. The loan results in a lump sum deposited into your bank account. From there, I can use a free ACH transfer over to Crypto.com or Voyager for creating DeFi-based passive income. If I were to use a regular credit card purchase, I would be charged 2.99%.
This is important because every month, I return this lump sum back into my account to pay off the card in full to prevent any interest payments or leave a large balance on my card. If I had to pay that credit card service charge every month, I’d lose money every month and this trick would not work. But the magic of the loan and free ACH transfers make this possible.
Repeating this cycle every month essentially provides me with 5 figures worth of debt on a revolving basis, completely interest-free, to use for passive income generation.
Notes regarding your credit score.
You should pay off your debt each month, in full, to prevent a large balance sitting in your account. This is important to prevent interest expenses. But it is also important for your credit score. If you are left with a large balance, your credit utilization (how much of your credit you use) will be very high. And a high credit utilization is not good for your credit score. Keep a close watch on your credit score as you try this trick to ensure you are not causing any damage to your score. If all is well, you might find out you will actually start increasing your credit score by demonstrating you can effectively use debt and pay it back responsibly month after month.
2. Secured Portfolio Lines of Credit
Unlike credit cards, a portfolio line of credit requires...well...a portfolio. My brokerage account through Wealthfront, a robo-advisor, provides a line of credit against your portfolio once it crests $25,000. Here, you use your portfolio as collateral to borrow up to one-third of your account balance.
Currently, the interest rates on these lines of credit, at the time of writing this, is a very reasonable 3.65%. [Update: Interest rates are rising! Up to 5.15%. Still a useful source of debt, but it got a little more expensive!]
A significant advantage to this form of debt is that Wealthfront does not require specific payback rules such as required monthly payments. This is nice, because you can essentially hold on to this loan as long as you’d like (as long as the market doesn’t fall and you are forced to add funds to your account or pay back your loan).
Repeating the same DeFi protocols for stablecoin staking I use for passive income generation, I simply deposit my portfolio line of credit into my account to start earning 12% back, netting the difference between the interest rates (12% - 3.65% = 8.35%).
As long as the return you make is greater than the cost of borrowing, you can use this debt to grow your wealth! And while there are many investing options that will earn more than 12%, I like this approach because of its low risk and low volatility.
If I invest my debt in a company's stock I'm excited about, I may earn hundreds if not thousands of percent in growth. But I could also lose that amount and end up underwater with my loan. To avoid that, I choose to stick with a stable return offered by these staking rewards. In addition, these rewards get paid out weekly, as passive income, as opposed to valuation growth like a stock.
3. Indirect IRA Rollovers
Turns out, you don't need to wait until retirement to take advantage of some of those funds locked away in your retirement accounts.
This is perhaps an odd trick I stumbled upon. I was searching for various sources of debt I had access to, and realized I had a decent chunk of my savings locked away in IRA accounts (again, through Wealthfront).
Typically, you can’t do much about that. The whole point of IRA accounts is to hold on to them until retirement-age to make use of the tax advantages.
And believe me, I still plan on doing that.
But once a year, the IRS allows you to remove those funds for 60 days penalty and tax-free. Other financial institutions have written about your ability to perform this procedure, called an indirect rollover, for a short-term personal loan.
Obviously, this is risky if you have any concern you will not be able to repay the loan. If you do not put back the same amount of funds you withdrew from your IRA within 60 days, you are forced to record that money as income (rendering income tax) and an early withdrawal (likely triggering a 10% penalty and the loss of future tax-advantaged growth).
Nevertheless, I’ve used this trick to temporarily deposit funds into my account, earn DeFi-based passive income for over a month, and return those funds before the 60-day window to give myself access to a short-term, interest-free loan.
This trick can only be used once per year, per IRS regulations, so it’s not going to likely be your primary source of passive income. But for me, it’s enough to cover one month’s worth of expenses!
Not bad for interest-free debt I didn't realize I had access to!
How I use debt to generate passive income
Once I've secured this debt, I use decentralized finance (DeFi) methods like staking to earn passive income.
There are many avenues you can take for earning income through various DeFi protocols, but I'll explain how I use stablecoin staking for low-risk passive income generation.
Think of stablecoins as an intermediary between cryptocurrencies and fiat currencies like the US dollar. Although stablecoins are digial assets built on blockchain technologies like other cryptocurrencies, they are always pegged to the US Dollar so that you can always exchange them one for one in either direction.
And think of staking like a certificate of deposit (CD). You lock your money up for a period of time to help support the coin's ecosystem and in return you earn rewards (i.e. money). The rewards are usually paid out in the same cryptocurrency that you are staking. But in our case, stablecoins are equivalent to dollars.
Although there are many platforms for staking, I like Crypto.com because you can use ACH transfers to deposit and withdrawal funds for free, and conversions of fiat to stablecoins are similarly free.
Now, you certainly don't need to use this approach to passive income using your debt, but I like this approach for a few reasons.
It does not require skill or work. You simply deposit your funds are start earning immediately.
Compared to many other investments, the risk is relatively low. You are not at risk of losing your principal deposit (unless the platform you are using goes under), and you are not at risk of market volatility.
Reliable passive income. You get paid weekly for as long as you want to keep your money in the platform.
Good return. For such a steady, low-risk place to park your money, my current return of 12% is far better than a savings account, a CD, blue-chip dividends, or even the long-term average S&P 500!
So what are the risks?
As mentioned in point number 2, the platform you are using could go under. Stick with well-known platforms that have been in use for a while. The world of crypto is still very early, so this is certainly a risk. Your deposits have no guarantee. If the company tanks or decides for any reason not to let you get your money back, it could be gone forever.
There are unforeseen regulatory risks, as well. Might the government decide these coins are against its interests and try to prevent or block their use in myriad ways? This could potentially directly hurt your assets, or perhaps indirectly by disrupting market conditions.
There are also smart contract risks you should be aware of.
And that's how I use debt for passive income generation. You can start today if you want. With the credit card trick, you don't even need cash in the bank!