Borrowing money and taking on debt is the only way most people can afford to purchase important big-ticket items like a home. This doesn’t just apply to the people working on 9 to 5 jobs it applies to everyone. While those kinds of loans are usually justifiable and provide value to the person taking on the debt, there is another end of the spectrum that involves debt that’s taken on carelessly.
Good debt has the potential to increase your net worth or enhance your life in an important way.
Examples: Education / Your Own Business / Your Home or Investment Property
Examples: Cars / Clothes / Consumables
What Is Good Debt?
Good debt is often exemplified in the old adage “it takes money to make money.” If the debt you take on helps you generate income and build your net worth, then that can be considered positive. So can debt that improves your and your family’s life in other significant ways.
What Is Bad Debt?
It’s generally considered to be bad debt if you are borrowing to purchase a depreciating asset. In other words, if it won’t go up in value or generate income, then you shouldn’t go into debt to buy it.
7 Reasons why debt can be good for you:
- Make Money using Debt.
By leveraging your savings and equity, you can borrow more money to invest in a property as an appreciating asset. Very few people ever “saved” their way to retirement. Using bank finance to acquire multiple properties is a smart way to build your property portfolio. The amount you can borrow from a bank will be determined by your income and other assets. The amount you leverage will depend on your age and stage in life.
- Disciplined Spending
Taking on more debt makes you seriously watch your spending habits. With more money at stake it’s important to have a good handle on where your money flows each month. Having a property debt also means you have a type of forced savings program. What would you spend your money on if you didn’t have to cover a home mortgage and other property debts? You would probably spend it on consumable and lifestyle items that depreciate rapidly.
- Debt gives you a Long Term Focus – FUTURE PROOFING
Using debt to buy a property (or properties) is not a short term strategy. It gives you a long term focus toward retirement. By working out how much you want to retire on, you can easily work out exactly how much debt you need to take on to achieve your goals. For example, if you want to retire on a passive income of $100,000 pa, simple modelling shows you would need to have $2 million of net property assets at retirement age earning a rental yield of 5%. But to obtain $2m of net assets, you would need to acquire a total property portfolio of $4 million using leveraged debt over a period of time (say around 10 to 15 years) then sell around half of the portfolio to pay down the debt.
- Tax Deductibility
Obtaining debt to invest in property means the interest on the loan and other costs are tax deductible. This is one of the reasons why property debt is also called “good debt”. However, don’t just select a property investment solely for tax benefits (this is only the icing on the cake).
- Allocates Resources to Highest End Use
Using debt for investment purposes will make you consider where you can get the best return. The return you get on the investment should outweigh the interest you pay on the loan over time. Negative gearing, neutral gearing or positive cashflow strategies are all useful and legitimate strategies for property investors.
- Cheap form of Finance
With interest rates at all time historic lows, taking out investment property loans to grow your portfolio is a smart move. Taking on new debt can make more sense than liquidating other assets such as shares or bonds.
- Even out your Cashflow
Having a line of credit or off-set account is a smart way to even out your cashflow as a property investor. Sometimes as investors we may get hit with a few big expenses all at once.