Using Debt Well: A Decision Framework

Everything in this chapter reduces to two questions, asked in order. Most borrowers ask only the first, and the second is the one that ruins people.

Question one: does the spread work after tax? Borrow only when the after-tax cost of the debt is below the after-tax return of what the money does, compared against a risk-matched alternative:

Two disciplines make this honest. Deductibility is the exception rather than the rule — personal interest is disallowed outright and every deduction must be earned through tracing (section “Interest Tracing: How Loan Use Determines Deductibility”) — so assume ${\tau }_{\text{eff}}=0$ until you have proved otherwise. And borrowing is certain while returns are not, so comparing a guaranteed 6% cost against an expected 8% equity return overstates the case; the risk-matched comparison for guaranteed debt is a bond yield, which is why the spread is usually thinner than it looks (section “Prepay or Invest? Compare the Right Two Things”).

Question two: what drawdown forces me to sell? This is the one that matters, because the spread determines how much you earn and the callability determines whether you survive to earn it. Rank every liability by how quickly someone else can demand it back:

Non-callable

A fixed-rate mortgage. The lender cannot accelerate because your collateral fell in value; you keep the option to wait. This is the single most valuable feature of residential mortgage debt and the reason it is the cheapest safe leverage most households will ever access (section “The Investment Showdown: Property Growth vs. Stock Market Gains”).

Callable on demand

SBLOCs, pledged asset lines, and uncommitted private-bank facilities. Callable at the lender’s discretion, for any reason, with little notice — and the reasons arrive in clusters, because the market decline that impairs your collateral is impairing everyone else’s simultaneously.

Callable automatically

Margin. No human decides; a threshold is crossed and the position is liquidated at whatever the market offers that morning.

The unifying rule: never fund a long-horizon or illiquid asset with a liability that can be called before that horizon. Every leverage blow-up in this book is a version of that mismatch — the 2021–2023 syndications that bought ten-year business plans on floating-rate bridge debt (section “Investing Passively: Syndications and Private Real Estate Funds”), the retiree whose SBLOC was called in a drawdown (section “Buy, Borrow, Die in Retirement”), the interest-only borrower who planned to refinance into a credit market that had closed (section “Interest Only (IO) Loans”). The asset was often fine. The funding was not.

Size against the decline, not the advance. Lenders quote a maximum; the maximum is their risk appetite, not yours. Work backwards from the drawdown you intend to survive using the margin-call price (section “Asset Backed Loans (ABL)”), and keep the draw at roughly half the available line so a normal correction is an inconvenience rather than a forced sale.

The five legitimate jobs for debt. Acquisition leverage on a productive or appreciating asset; a liquidity bridge that avoids a forced sale or a tax realization; tax-character arbitrage (section “The Tax-Deductible Debt Swap”); wealth transfer (section “Debt as a Wealth-Transfer Tool”); and buying an option you cannot otherwise buy — an undrawn line opened while you still qualify (section “Layered Liquidity for Households”). Consumption is not on the list and never joins it. Revolving credit at 20%+ carries none of the upside and all of the cost, which is where this chapter began.