4 Reasons Why All Debts Are Not Bad And Why You Should Sustain Them
Using Debt Wisely To Grow Property Wealth Faster
But do you know that all debt is not BAD?
The world holds the misconception that debt is a significant threat to personal and business finances. There is some truth in it. But, it is certainly wrong to generalise, though. The debt against a luxury item you only use for special occasions is certainly a threat. However, debt against a rental property that generates income is not.
So, we must classify them first. Debts are frequently categorised as good or bad debt because they can have either beneficial or detrimental effects. An easy distinction is that while bad debt will hurt your borrowing capacity, good debt may help it expand.
Now you will think, how are they different?
Debt is good debt if it increases your net worth or has future value. But if it doesn't, and you don't have the money to pay for it, the debt is considered bad debt.
Debt typically belongs in the "things to avoid" category because of its negative connotations. Yet, savvy property investors know that debt can be a powerful SECRET weapon, enabling you to capitalise on your current equity and increase your wealth much more quickly.
The top 1% of successful real estate investors know that debt against a suitable property is not considered bad debt. If you own a rental property, your tenants are helping you pay off the debt. You are simply turning your debt into an asset rather than a significant expense. Our debt recycling guide covers the mechanics of this conversion in detail: how to use investment borrowing to accelerate the paydown of non-deductible debt.
See?
Sometimes, borrowing money makes financial sense. If you manage your money and debt responsibly, you can take your life to the next level.
1. Use debt to your financial advantage
A smart way to expand your real estate portfolio is to buy several properties through bank financing. Your income will affect the amount you are eligible to borrow from a bank. If you are making a lot of money, you might be able to borrow 90% of the loan. Our borrowing capacity playbook covers the practical steps for maximising and preserving borrowing capacity as your portfolio grows.
Choosing real estate assets with a high potential for capital growth and little chance of vacancy is the key to effective debt leveraging. Once the asset value rises over time, you might be able to refinance the loans to use the increased equity as a down payment for your following property.
A word of caution is not to overdo it. There has to be the right balance, and the strategy should conform to your risk profile.
2. Debt helps you prepare for the future
Using debt to buy properties is a long-term strategy focusing on retirement. Establish a retirement budget, then determine how much debt you will need to incur to reach your retirement goals. For instance, if you want to retire with a passive income of $80,000 per year, you need to have $2 million in net real estate assets (assuming a 4% net yield). Potentially, one can use leveraged debt to accumulate a $4 million portfolio over time to obtain $2 million in net assets, then sell about half of the portfolio to pay off the debt. (Refer to #GetRAREmodel for details)
3. Tax deduction
The interest on a loan taken out to invest in real estate is tax deductible. For this reason, property debt is referred to as "good debt". But, don't just select a property investment solely for tax benefits. Nobody has ever grown rich on the back of the strategy of saving tax alone.
You need to take capital growth and yield fundamentals into account.
4. Utilises resources most efficiently
Utilising debt for investments will force you to consider where you can earn the highest return. The interest you pay on loan should be outweighed by the return on your investment. By investing in well-selected property assets, you are building a nest egg for yourself.
In summary, start weighing the pros and cons of every debt you take and do everything you can to make the good outweigh the bad.
Remember that debt is like a chainsaw. When you're ready to start and work out your real estate investment strategy, get it going, but handle it with caution.
Now you have the necessary information to distinguish between good and bad debt. Having this knowledge will already improve your future investments.
At Get RARE Properties, we will support you on your property buying journey by helping you avoid mistakes and giving you an insight into the property market Australia-wide. The whole idea is to pick assets that are outperforming the markets.
We select properties based on strict criteria and inspect several properties to ensure that the one you choose is the best fit for your needs according to your strategy. We can also represent you in negotiations with real estate agents, ensuring you get the best deal possible.
If you want help applying these principles to your own debt structure before your next acquisition, a strategy call is the appropriate starting point.
Disclaimer: This article is general in nature and does not take into account your situation. You should consider whether the information is appropriate to your needs, and where applicable, seek professional advice from a financial adviser.
