Good Versus Bad Debt – Is Real Estate Debt OK?
Here’s a very basic conversation about “Good Debt” versus “Bad Debt”
Is there such a thing as “good debt”? Years ago, I considered “good debt” to be an oxymoron.
This good vs. bad debt conversation comes up a lot in real estate conversations. Especially for investors just starting out. And, typically, understanding “good” debt has proven more difficult for women (sorry girls). We, it seems, are much more concerned about paying the bills today for our home and our children. After all, doesn’t most of society tell us that debt is bad? So, how is some of it good? And why?
My husband and I argued about “good debt” vs. “bad debt” for two and a half years before I finally got it (and by “it”, I mean I finally understood his argument). I wanted no debt and was absolutely NOT interested in finding something called private money lenders. Why in the world would we want even MORE people – besides mortgage companies – to owe money to?!?
But, ultimately, I became convinced. “Good debt” is a real thing, and not just an oxymoron. I learned about something I had not previously understood – Leveraging.
Here’s one definition I found for leveraging: “using borrowed capital for (an investment), expecting the profits made to be greater than the interest payable.”
Yes, “profits made to be greater than the interest payable” means you can pay back the lender and still have profits (money) left for yourself. If you do this once, it’s a wonderful thing. If you do this ten times, it can be incredible. So, done right, taking on more “good debt” can increase your own long-term profits.
Not all debt, naturally, leads to profits – not a big screen TV or another car, but investment debt done right definitely can. Here’s a very basic way to look at it:
Say you personally have $100,000 cash. You can purchase one house for $100,000 and get $1000 per month rent for it.
Or, you buy ten $100,000 houses, putting $10,000 down for each, and get $1,000 per month rent from each house. Yes, you have debt to pay to the borrower on each one, but you also have profits left for yourself on each one.
- You only need $100 profit left on each to still receive your $1000 per month income.
- Plus, you have someone else paying off those mortgages.
- Plus, you receive tax write-offs on the interest you pay to your lenders.
- You receive additional tax write-offs on the depreciation on those properties.
- Over time, your tenants, not you, pay off the mortgages.
- You end up with ten houses each paying $1000 per month rent. Rather than the original one house paying $1000, you now have ten houses paying $1000. And you still only paid out your initial $100,000 for ten times the reward.
Now THAT’S leveraging!
Another important fact when purchasing real estate is that you have an asset against your debt. It’s not like borrowing for a bigger TV or even for a car where the purchase has little to no value. In fact, those aren’t assets but liabilities. With real estate, if circumstances go awry, you have the option to give the asset to the lender to satisfy the debt. A much safer deal for everyone.
Begin to see this “good” debt is as an investment in your future. The important thing is that you must buy right. Be sure to buy at a deep discount, never pay full retail. That leaves plenty of room to maintain value even if the market and property values drop (remember 2008, 2009 and 2010?).
Does this make you think of real estate debt differently? What can you add?