Many investors feel it is okay to invest in good debt, but you should stay away from bad debt. I have a completely different viewpoint when it comes to real estate investing. I don’t think there is a difference between good debt and bad debt if you are investing the money from that debt into something that makes a lot more money than the debt costs. If you can make more money on the investment than what the debt costs you, I feel debt is good in most cases. There are some instances when debt is bad if you are using it to fund a lifestyle you can’t afford and not investing the money.
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What is good versus bad debt?
Traditional thinking states good debt is debt used to finance a stable or appreciating asset. For example: if I buy a house with a mortgage that house will most likely appreciate making the mortgage good debt. If I were to use a bank loan to build a business, then that would be good debt because the business will hopefully make me money and increase in value.
Bad debt is typically thought of as money owed against depreciating assets. Loans against cars, furniture, televisions would all be considered bad debt, because the collateral is depreciating or losing value. The reason people think this is bad debt is because the assets will lose value and not make you any money.
Do I use good or bad debt?
I have a lot of bad debt and a lot of good debt if you use the traditional definition of debt. However, I don’t agree with the traditional definition of good versus bad debt. I have loans against my cars, which would be considered bad debt to most people. I don’t have any loans against furniture, televisions or other consumer goods, but I have a lot of mortgages against real estate.
I have 11 mortgages on my rental properties and principal residence, plus I have a line of credit against one rental that is paid off and I have nine more mortgages against my fix and flips. All that debt would be very scary to many people, but I love it because it makes me a lot of money. The more debt I have, the more money I can invest into income producing assets.
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Why I don’t believe in good debt versus bad debt
I have loans against my cars including the Lamborghini. I don’t think the Lamborghini is a depreciating asset, but that is not why I got a loan on it. The reason I have loans on assets that don’t make me money is I can invest the cash I would have spent on those items into more real estate.
I usually make at least 20 percent cash in cash returns on the money I invest Into rentals. That doesn’t include equity pay down, appreciation, or the tax advantages of rental properties. My interest rate on my car loans varies from 2.9 percent to 5 percent. A 20 percent or higher interest rate is a huge difference from 5 percent or less.
In fact the $30,000 or $40,000 loan against my car can be used to buy a rental property that will produce more income that my car payment. If I paid cash I would not have a car payment, but that $40,000 would be tied up in the car. With a loan I am able to put $30,000 into a rental property, which covers the car payments. When I get a loan on the car I still basically have no car payment and I was able to buy a house as well!
Do I pay off my house or car loans early?
Not only am I fine with getting loans on depreciating assets, I don’t pay off those loans early either. I would rather use the money I save by not paying off loans, to invest in more rentals. I also don’t pay off my personal residence either, because my interest rate is 4 percent and I can make much more money investing in rentals. This is a very aggressive strategy that is not for everyone. Some people are very risk averse and hate debt. If debt makes you sick to your stomach you may not want to use this strategy.
A word of warning concerning debt
Before I get too far into my debt strategy I want to emphasize that debt can be very bad. I could buy my cars with cash if I had too; I am not using debt to buy material goods, because that is the only way I could afford them. People get in trouble with debt when they use it to live a lifestyle above their means. If you have to finance a $40,000 car because you have no savings and no extra money, is that a good idea? If you can’t save any money without the $40,000 car loan do you think you will be able to save money with a $40,000 car loan?
I drove a 1991 Ford Mustang as my daily driver for eight years. I bought the car with cash and never had a car payment until I was almost 30. I still have never bought a brand new car even though I am a car lover and enjoy my cars immensely. You don’t have to buy $40,000 brand new cars to enjoy life.
When I talk about using bad debt to fund real estate investments that is not a green light to buy whatever you want on your credit card. It is an idea of how to use debt on things you may otherwise buy with cash and you can comfortably afford. I am all about rewarding myself and buying things that make me immensely happy. However, I also made a lot of sacrifices to get where I am now. If I had spent every penny I had before I started investing I would have never been able to buy rental properties. The more you save and invest early in life the better off you will be.
What if the debt costs more than your investments?
My rental properties bring in at least $500 a month in cash flow every month. That cash flow is income after I pay my mortgage, taxes, insurance, maintenance and vacancy costs. That income more than covers the debt service on the rental properties and the debt I used to pay for down payments. If I was not making any money on my rental properties and I had all this debt I would be much more concerned. I think it is risky to accumulate a mass of debt if your only goal is to buy as many properties as possible that don’t make much money or any money at all. If rents decrease, properties go vacant, you lose your income and you don’t have enough reserves it can lead to disaster.
I use a very aggressive debt strategy, but I also make a very good living and I have reserves in place if something were to happen to me, my income or my properties. The income from my rental properties more than covers the debt against them, the debt against my cars and even my personal house. I think almost all debt is good if it has a much lower rate than my investments and I can comfortably afford the debt. If you want to use a super aggressive debt strategy make sure you run the numbers and you are not risking too much for too little return. Here is a great read if you want to see how I am using debt to try to buy 100 rental properties.