Good Debt and Bad Debt
Most people are afraid of debt. Most people have experienced debt or currently have some debt.
Yet most rich people have tons of debt.
There are two kinds of debt: Good Debt and Bad Debt.
When regular people think of debt they are usually thinking of bad debt.
Bad debt is the kind of debt you get by purchasing consumer goods that depreciate and that don’t provide any kind of financial return. For example, your car, your trips, furniture, clothes, etc.
I’m not saying don’t enjoy these things … just don’t go into debt to buy them. And only after you have your savings and investment program well under control.
Usually this debt starts as credit card debt or consumer loans. And this debt has a very high interest rate and can take a long time to pay off.
You should never borrow for consumer products. Save first and then purchase what you want or need. And even then … make sure you really need this item.
Good debt, on the other hand, is debt that is used to acquire an investment.
For example, you can borrow money from a bank to purchase a rental property, or from investors to acquire a Lease Option, or even take out a loan to invest in a higher return mortgage.
As long as you are getting a positive cash flow then it is good debt (no, your boat or jewellery is not considered an investment). And if your investment also appreciates, that is a bonus. And your personal residence is not good debt.
It amazes me that people are afraid to take on this debt because they are afraid that they might get stuck with the monthly payments.
For example, if the rental unit is empty, how do they make their monthly mortgage, insurance and tax payments? Proper planning and vacancy reserves will fix that.
Yet somehow these same people are OK purchasing a new stereo on credit and making the monthly payments because they don’t have the money to pay off the balance every month.
Because people have had so many bad experiences with bad debt, they are very hesitant on taking on any good debt.
I see this everyday with people who own their own home and have their home completely paid off. They are proud of the fact that they are mortgage free. They are sitting on this big pool of dead equity that isn’t earning them anything except for the appreciation, and that only helps them if they sell.
If they were to take out a mortgage on their home for let’s say 3% (roughly today’s rate) and invest it in high ratio mortgages or any other investments at say 13% (average returns I guarantee my investors) they would make an easy 10% profit.
If their house is worth $300K and they took out an 80% loan to value mortgage, they would have $240K to invest. At 10% that would be approximately $24K extra income per year. Not bad for just refinancing your home.
Rich people aren’t rich because they make more money. Rich people are rich because they know how to manage their money. And they know how to manage their good debt.