Good Debt Vs. Bad Debt
Isn’t all debt bad? NO! I operated under this delusion for many years, but thankfully, I saw the light a couple of years ago! Had I still believed this I probably wouldn’t own even one rental property right now!
Don’t get it twisted, there are a lot of bad debts, and all debt must be accrued with caution, but there are some debts that can be leveraged to create additional streams of income for us, and this Is a good thing!
How can debt be good?
Debt used as leverage to earn additional streams of income is considered good. Almost any form of debt can be turned into good debt, provided it is used for the purchase of an asset. Generally speaking, good debt has a lower interest rate too, and that can make it even more beneficial.
An example of this would be that I pay $595 a month for the mortgage on my duplex (including tax/insurance), and owe $75,000 on the mortgage in total. Every month that property brings in $1,015 (minus repairs/fees) and gives me a net monthly income of roughly $300. In this example, I have $75k in debt, that costs me $595 a month, but I make $300 profit from this loan. If I didn’t take out this mortgage I would be $300 poorer every month, and therefore this is considered good.
An auto loan can be a good debt if used for Uber/Lyft, or as a company vehicle that earns additional income, or tax write-offs, that total more than the monthly payment.
Examples of good debt
-Mortgage (on asset properties)
-Business ownership (that makes money)
-college (assuming it increases salary)
-Auto loan (that earns you money)
Bad debt is that debt which costs you money every month to maintain. This debt usually comes with a higher interest rate and does not put money in your pocket. I would strive to avoid bad debt at all costs!
An example of bad debt that almost everybody has (myself included) is credit card debt. Credit cards accrue an obscene amount of interest (generally 10-20% in today’s mark). Credit cards are not inherently evil, but the majority of people use them as cash reserves while trying to make ends meet between paychecks.
This utilization of credit leads to unnecessarily large credit card balances, and it becomes easy to reach a point where it seems impossible to pay them off. I would recommend keeping a low credit card balance, and never resorting to credit for unnecessary purchases!
Auto loans are more often than not considered bad debt. I would recommend purchasing a vehicle in cash whenever possible, and I would suggest purchasing a vehicle 3-15 years old. It is generally not in your best interest to purchase a new vehicle due to the depreciation in value that occurs immediately after driving off the lot.
Examples of bad debt
-Auto loan (that doesn’t earn you money)
I hope this eliminates the stigma that “debt is bad” and allows you to see that debt (leverage) can be used to multiply your net-worth! I know that learning this concept helped open my eyes to new possibilities, and the more I am able to leverage my funds the faster I will grow my portfolio!
What do you think about debt?