All over the internet people are touting the importance of being debt free.
Debt is bad!
All debt will ruin your life!
Debt is the number one reason for divorce.
Yadda Yadda YADDA!
…don’t get me wrong, debt certainly can be all of those things.
However, if used correctly, there are some great advantages to utilizing debt in your life!
Investments > Low-Interest Debt
The first advantage of debt is that low-interest debt doesn’t cost very much.
At a 4% interest rate, it costs only $40/year for every $1,000 you borrow.
For this reason, I would usually prefer to buy a car with a low-interest auto loan, than to pay for it in cash. I can easily invest $10,000 for a higher return on investment than the auto loan will cost me.
If I were to buy the car in cash, I would essentially be earning a return equal to what the low-interest debt would have cost me.
Once the car is paid off, the loan disappears.
At that time, I will still own the investment I purchased with my $10,000.
The bottom line is this if the interest rate on your debt is higher than the return on investment would be from investing, pay the debt off first.
If the return on investment is higher than the interest rate on your debt, don’t let the debt bother you.
If they are pretty similar rates, do whatever makes you feel the most comfortable.
At the end of the day, a warm and fuzzy about your finances is always good to have!
Leverage
The magic of real estate investing is the use of leveraging a bank’s money, for your benefit.
Leverage allows you to turn $20,000 into the ownership of a $100,000 property.
The problem some people have with leverage is that its debt.
I consider leverage to be good debt.
Good debt is any debt that helps me build wealth, and earn money.
For example, if I take on a large amount of debt to purchase an apartment complex, but that apartment makes me money after all expenses are paid, it is 100% worth taking on the debt.
If you are risk-averse, and only purchase real estate in cash, it will take you much longer to build a portfolio of real estate.
Another benefit to leveraging debt for real estate investing is that the interest paid on your mortgage is a tax deduction. This helps write off more of the income received from your property, while STILL receiving the cash flow, and having tenants pay for your debt!
Asset Protection
I am currently embroiled in a lawsuit.
I did not want to sue, but life happens, and sometimes it is the only solution to a problem.
Upon filing the lawsuit my opponent added m personally to the lawsuit. Scary right?
Not really.
All of my assets are owned by limited liability companies (LLC’s), which protects them from a personal lawsuit against my person.
All I own with my name is two cars, and a primary residence.
Both of my cars currently have liens against them, and my primary residence is highly leveraged between the mortgage and a HELOC.
Because of this, it makes no sense for the other party to go after me personally because, on paper, I’m not worth anything.
The court could force the sale of my property in order to pay the other party if I owned these assets free and clear.
I like knowing that my asset is cash flow positive, tenants are paying my loan down, AND providing me additional asset protection!
High-Interest Debt
Now, is all debt good?
Absolutely not!
I’ll admit, the title of this article is a little misleading. While it isn’t a lie, it certainly isn’t the full truth, either.
I do intend to be free of all high-interest (bad) debt in life.
If the interest rate on my debt is higher than I can earn through investing, I will absolutely pay it off ASAP. If the debt is hurting my credit score (I.e. over-utilization of credit cards) I will pay it down quickly.
The bottom line is this, debt is dangerous. If you’re going to play with fire, you need to wear all of the proper safety equipment and keep a water source nearby.
I will advocate for reasonable debt, and leveraging debt all day, every day. I will not, however, advocate for digging your financial grave by running amuck with your credit card.
Currently, I have more on my credit card than I would like due to a move, legal fees, and some other things that have come up. As such, I have re-allocated funds to pay this down ASAP so that I can continue building capital for my next investment.
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)
-Investing
-college (assuming it increases salary)
-Auto loan (that earns you money)
Bad Debt
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
-Credit card
-Auto loan (that doesn’t earn you money)
-Consumer debt
-payday loans
-cash advances
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!
Should You Strive To Be Debt Free?
Dave Ramsey has some great advice for getting out of debt, and I am a fan of the baby steps.
I would deviate from the baby steps once you’re free of bad debt.
Buying real estate with cash is safe, but it is very hard to scale. It also doesn’t provide quite as much asset protection as having a mortgage on the property does.
I hope this article helped change your attitude towards debt. Some debt is bad, and some debt is good.
Debt is nothing more than a tool for you to keep in your arsenal. Like any tool, it can be used to create something beautiful or to tear things down.
*WARNING* There is risk associated with debt, leverage, etc. Be careful not to overextend yourself, and always stay well within your comfort zone!
8 Responses
Great article. I think handling debt requires a large amount of discipline, and so does not borrowing a lot of debt. Question for you. How do you measure risk? Meaning when and how much you borrow?
I generally just look at the worst-case scenario, and if it is survivable then I look at the possible upside, likelihood of each, and weigh them accordingly. If I’m comfortable with what could go wrong, then I’m all for the risk!
WOW….Good debt? Are you hearing yourself?! DUDE!!!!! IF the bank/s decide to want their money yesterday YOU are F.U.C.K.E.D!!!!!!!!!!!! ( Just Ask Dave Ramsey ) Dave once thought as you do right now. “Leveraging”, “Use the bank’s $$” and soforth. It all came crashing down on him and he was dead broke as a result.
If THAT’S The way you wanna go then have at it. As for myself, I’m gonna stick with being debt free and owing nothing to no one.
All of this could have been said without the language and attitude, but suffice it to say I disagree. Obviously, over-leveraging (like Dave did) is bad, but mortgages themselves aren’t.