Good Debt Versus Bad Debt – Is Real Estate Debt OK?
Here’s a very basic conversation about “Good Debt” vs. “Bad Debt”
Is there such a thing as “good debt”? Years ago, he considered “good debt” an oxymoron.
This good vs. The bad debt conversation comes up a lot in real estate conversations. Especially for investors who are just starting out. And understanding “good” debt has generally been harder for women (sorry, girls). We, it seems, are much more concerned with paying the bills today for our home and our children. After all, doesn’t the majority of society tell us that debt is bad? So how is a good thing? And because?
My husband and I argue about “good debt” vs. “bad debt” for two and a half years before I finally got it (and by “it”, I mean I finally got the point from him). He didn’t want debt and was absolutely NOT interested in finding something called private lenders. Why in the world would we want MORE people besides mortgage companies to owe them money!?
But finally I was convinced. “Good debt” is a real thing, and not just an oxymoron. I learned about something I hadn’t previously understood: leverage.
Here is a definition I found for leverage: “to use borrowed capital for (an investment), hoping that the profits obtained will be greater than the interest to be paid.”
Yes, “earned earnings are greater than interest payable” means you can pay the lender back and still have earnings (money) left over for you. If you do this once, it’s a wonderful thing. If you do this ten times, it can be amazing. So if done right, taking on more “good debt” can increase your own profits in the long run.
Naturally, not all debt leads to profit: not a big-screen TV or another car, but investment debt done right can definitely do it. Here’s a very basic way to look at it:
Example 1:
Let’s say you personally have $100,000 in cash. You can buy a house for $100,000 and get $1000 a month in rent for it.
Example 2:
Or, you buy ten $100,000 houses, putting down $10,000 each, and get $1,000 a month in rent on each house. Yes, you have a debt to pay to the borrower on each one, but you also have profit left over for yourself on each one.
- You only need $100 of profit on each to receive your income of $1000 per month.
- Also, you have someone else paying those mortgages.
- Plus, you get tax deductions on the interest you pay to your lenders.
- You receive additional tax deductions on the depreciation of those properties.
- Over time, your tenants, not you, pay the mortgages.
- You end up with ten houses, each paying $1000 a month in rent. Instead of the original house paying $1,000, you now have ten houses paying $1,000. And she still only paid her initial $100,000 for ten times the reward.
Now THAT is leverage!
Another important fact when buying real estate is that you have an asset against your debt. It’s not like borrowing for a bigger TV or even a car where the purchase has little to no value. In fact, those are not assets but liabilities. With real estate, if circumstances go wrong, you have the option of turning the asset over to the lender to pay off the debt. A much safer deal for everyone.
Begin to view this “good” debt as an investment in your future. The important thing is that you should buy right. Be sure to buy at a deep discount, never pay full retail price. That leaves plenty of room to hold value even if the market and property values drop (remember 2008, 2009, and 2010?).
Does this make you think about real estate debt differently? What can you add?