Have you heard the phrase “There are two kinds of debt: good debt and bad debt”? I believe that’s a bunch of bollocks put forward by lenders to throw a cloak of “normality” over a life of financial servitude, and to boost their profits.
“There are two types of debt: bad and worse”
This week’s Steve-ism (see above) indicates that all debt is bad (i.e. none of it is good!), and some of it is worse (i.e. toxic).
Debt is borrowing future income that you haven’t yet earned, and spending it now. The by-products of getting into debt are that you are ‘selling’ future time where you have to work (or earn) to repay it, plus you have to pay the cost of servicing it.
Watch this video to see how I use debt sustainably:
Now don’t get me wrong, debt (i.e. accessing other people’s money) is needed for leverage, and leverage is needed to accelerate wealth creation. Perhaps rather than calling debt good, in some circumstances, (e.g. in the hands of a diligent investor), debt might be better termed dangerously useful (rather like a double-edged sword). Yet debt is like yeast. A little can help in certain circumstances; but too much, or all the time, ruins everything.
“There are two types of debt: bad and worse” is a reminder that a problem exists when people see debt as normal and something to get in to and never out of, instead increasing their debt as time goes on rather than executing a plan to diminish and eventually eradicate it. Another word for debt is risk. If you have a lot of debt, you carry a lot of risk. Surely the goal should be “nodebt” and when you achieve this, you take a lot of risk off the table.
Are you using debt sensibly and sustainably? Or are you rather out of your depth in dangerous waters, and risk being caught in a debt-rip and being swept out to financial oblivion?
If you’ve had an “A-ha” moment, or have a comment or query to make, then post it below. Alternatively, you can browse what others are saying.
Until next time, remember that success comes from doing things differently.
– Steve McKnight
Hi Steve,
It’s funny you write this article, because I’ve believed in that saying until this moment! But it’s not completely wrong, because leverage is associated with debt, and anyone has gained wealth has had to use leverage at some point.. I don’t hold any regrets in pushing forward with my investing plans, I think it’s an excellent long term plan.
Thanks Matt.
I agree that in certain circumstances and trained hands, debt is a tool that can do a lot of good.
But life is a lot less stressful when you don’t owe anyone, anything.
I advocate responsible use of debt in trained hands in the short term, but to ultimately get out of debt in the long term.
Thanks for your contribution.
– Steve
Hi Steve, I definitely see your point here, worse debt is really terrible, that’s the people who like you said get into debt to fund their lifestyles like whacking expensive cars and clothes on credit cards and finance and don’t really have a specific plan or aspirations to pay it off, that’s terrible!!!!
I do however have a question, if someone was in a position to consider buying a second home, like let’s say they could be in a position in the mid term future to have their first property 85 – 90% paid off in this case would buying a second property be a viable option as the second property would then become an investment and provide and income and the potential tax benefits or would you still recommended the person to save their money and remain debt free and explore other investment options that may come with paying more tax?
Hi Sam,
There are two elements to my answer.
The first is that it only makes sense to borrow when the return is greater than the cost of debt. As such, it is the income return that ought to carry more weight than the expected capital appreciation, as your interest will need to be repaid in cash. If the rental yield is less than the cost of finance then other funds will need to be found to service the debt, and this creates risk. Another way of saying this is that it is dangerous to use paper profits to pay a cash expense.
The second element is that it is unwise to overweight or bias your investment decision based on taxation implications. That is, don’t let the tax tail wag the investment dog (another Steveism for another day).
Sam, your strategy as outlined is a growth strategy, and to get a so-called tax benefit (which is really a deferral) your expenses need to be higher than your income. If you are comfortable with the dynamic then your investment lives or dies based on its growth potential.
Sincerely,
– Steve
Thanks very much for taking the time to answer, you have provided some good advice and made things less ambiguous, your Steveism about the tax tail waging the dog is a really good one and is highly logical, I shouldn’t do it purely for tax benefits but then I have to factor in that it will provide me an income and that I still have plenty of working years ahead, in a worse case I feel I could sell it pay the bank and turn a small profit once I research further to ensure I pick the right place ,I shall do further research and seek more expert advice and then make an informed decision, thanks again Steve. :-) I’m open to any more comments/suggestions from other people on here.
Hi Steve
Your description of debt resonates with me more so now as I head to “retirement”. Lining up our assets with no debt is definitely the goal.
Thanks, Joce
Well said Joce. Your retirement will be much less aggravating without having to worry about debt.
– Steve
OK I have limited means to work after becoming disabled(no problem?) I have a little mortgage debt but desperately want to know, can i make a start investing when that mortgage is hanging over our heads.
Hi Neil,
That’s a tricky position to be in. There seems to be two issues:
1. What did you use the original loan (secured by the mortgage) to purchase?
2. Your ability to borrow given you stated you have little means to work?
You might need to rely on private money and JV partners rather than traditional finance.
Regards,
– Steve
Hi Steve
Agreement here! A personal goal I had was to ensure my home is free of debt. After that to ensure credit cards are paid off every month
Yes, I have used debt to assist me to purchase investment properties and also cross collaterisation if the need was there
My investment properties have been quietly paying themselves off over the mid term & leaving me with more equity to use
So I accepted that debt has assisted me to obtain
Properties I could never have bought for cash and the capital improved value has helped me buy more
As I move towards retirement (as I am over 65) my investment portfolio/super will keep us & the invest properties keep paying themselves off. Cheers. John
Sounds like a sensible investing strategy John.
Well done.
– Steve
Hi John, well done, sounds like you are doing well, may you please read my post and attempt to provide advice or give your view please.
Debt is a tool that is available to us to leverage other people’s money by accessing our future time and income now. This means that if you purchase lifestyle goods with debt you are paying for them now with your future earnings. If there is no healthy management of debt it means you have to work longer for instant gratification of the now.
“Bad Debt” as Steve phrases can also sink or swim you depending on how you manage it. Remember every income returning asset is positive cash flow if you don’t owe money. You don’t want to accept debt as a normality of your life.
God bless and keep pushing forward.
Great point Richard about every income producing asset being positive cashflow with no debt.
Well said!
– Steve
Definitely*
Stress from too much debt can be paralysing. It depends on your ‘risk profile’ when it comes to investing I guess, but for some, it can create alot of stress. And that can stop you in your tracks
“don’t let the tax tail wag the investment dog”
It puts a smile on my face just to read it …. :)
Another Steveism that delights !! Well done
Hi Steve, I believe in debt for leverage to buy assets where the cash income derived from the assets exceeds any reasonably perceived future costs of servicing that debt and where the asset purchased has an extremely minimal risk longer term of depreciating to the point where the LVR is goes over 80% and the cash flow generated from the asset also has an extremely minimal chance of depreciating by any real amount over the term of the debt.
Hence, the level of your debt and, more importantly, the price you are prepared to pay for leveraged assets depends upon a few important variables that you may wish to enter into your debt risk equation.
One is the percieved interest rate possibility that may occur over the term of the loan. I use 10%. Despite interest rates hitting 17% back in the 80’s I feel comfortable purchasing assets today using this number in my property price calculation.
So loan amount * 10% must be lower than rent (pa). example: $300,000 loan * 10% = $30,000 pa (+other costs associated with owning the asset -rates, insurance, repairs, vacancy etc – I use 1/2 the rent as a rough guide here: $15,000) so therefore the maximum debt allowable on an asset that I wish to purchase that generates a total of $45,000 in cash income cannot exceed $300,000. So if the property price is higher than $300,000 you have the option of either saving the difference as a deposit or not buying the investment property. I don’t like having to pay more than 30% deposit so the maximum I would pay for a property that generated $45,000 pa gross income would be $300,000 / 0.7 = $428,571. (deposit needed is approx $130,000 + stamp duty + blah blah blah)
Do I have any properties that I have purchased over the years that meet this criteria. Ans Yep. It’s hard work finding them but they do exist.
Great distinctions!!! Thanks Steve!
Thank you Steve, after reading your article I had a “light bulb moment” and understand exactly what you mean!
I am currently off loading 2 properties in WA owned for 10 years and have been a slave to mortgages and property managers for long enough. These properties represent my entire debt, after selling I will be debt free for once in my life, my current age 57.
I want to buck the trend and become debt free for a change and see how it feels :)
Thank you for your honesty, and keeping it real Steve.
Cheers,
Martin
Hi Steve, ‘bad debt’ or ‘worse debt’, what’s the answer? “Debt is only ‘useful’ when you can ‘use’ it!
As ‘self funded’ retires, (in our seventies), living on Government Pensions, and revenue received from two granny flats attached to our residence, my wife and I have utilised the ‘debt equity’ in our property to assist to fund our lifestyles. For the past 20 years we have had in place a ‘revolving mortgage facility’, (similar to a ‘Line of Credit’), with a $250,000.00 limit secured against our property valued at around $900,000.00.
Whenever the facility has been utilised, there is a calculated minimum monthly principal & interest repayment requirement by the lender. The benefits of the facility include, that it can be fully drawn down to the limit at any time, or be left undrawn for any period of time, and in addition to any monthly P & I repayments, the total ‘debt’ borrowings can be fully repaid, (e.g from other earnings, gifts, inheritance, or the sale of other property or chattles). The revenue from the granny flats exceeds any required monthly P & I repayments, (with some to spare).
Our thinking is such, that with the property value continuing to increase over time, (in our case from $253,000.00 to its current value), the sale of our property would easily settle the ‘revolving mortgage debt limit’, (in the event of our passing). Surely this debt then can only be considered as being ‘useful debt’ being ‘used’?
The revolving mortgage facility has also proved useful in being able to assist family, (e.g. with bridging finance, or with funding pending the receipt of benefits, divorce settlements or other funding).
Hi Rob,
I rather like how Steve starts out with a statement designed to disturb!! I think it is a very useful ploy where we need to re-think old adages.
We’ve all heard the “good debt and bad debt” adage before – but Steve says “Wait a minute… forget what you have heard for years – let’s start again and re-think this!” Then he goes on to add the “useful debt” comment into the mix, while all the while reminding us that we need to plan to eliminate debt (as you appear to have done).
Sounds like you have the whole thing sussed, so, well done.
Benny