Somewhere in history, it became a commonly accepted “wisdom” that all debt was bad.
Our parents worked their butts off during their lives to pay off their homes, because having a mortgage was something they believed should be done away with as quickly as possible.
While it remains true that you never want to retire with still having a mortgage to pay off, property loans should not be seen as bad.
Rather, they are simply vehicles to improve your financial future by using someone else’s money!
Now, when I say someone else’s, I really mean a bank’s money, which borrowers can recycle into making money for themselves.
Good vs. Bad Debt
In this scenario, then, we can classify a property investment loan as good debt, because it is used to invest in an income- and capital growth-producing asset.
Under the current once-in-lifetime low interest rates, it’s also never been cheaper to borrow funds to invest in something that will create wealth for you and your family over time.
A $500,000 investment property loan on a $650,000 property currently costs less than $300 a week in interest.
The rent you will receive from tenants to live in the property, location and property pending, is probably $500 or $600 a week on the Sunshine Coast.
That means that the property is already in positive cash flow territory.
If you add on the potential capital growth over five or 10 years, then you’re on to a very impressive wicket, courtesy of good debt.
Also using money to buy shares that is going to give you a dividend and capital growth can also be another strategy. As I’m a property person you probably will not get my recommendation on this as usually your superannuation is heavily swayed to share and managed funds.
In investing terms, we call the owner occupied home a bad debt as it is costing you money to own that property and you are not getting a return on that money. You are not allowed to claim a tax deduction on the interest or receive any income from that property. We all need somewhere to live, so if you are going to pay a mortgage or rent, you are still paying money out. Therefore, we often hear people say rent money is dead money. I do tend to agree with this statement. However, purchasing your own property is a way of forced savings as you are paying debt off and it is an asset increasing in value.
Importantly, I do not like to see people putting themselves under too much pressure, “keeping up with the Jones” and buying a property with a much larger debt therefore hamstringing you.
Real bad debt is for things that don’t grow in value, plus end up costing you more than they are worth eg car loans, credit cards and pay day lenders which usually have high interest rates attached. By the time these are paid off, it costs you more than it was worth on the day you bought it, plus the vehicle is now probably only worth half as much.
Plastic not so Fantastic
Credit cards are the worst form of bad debt as people tend to use the “plastic not-so-fantastic” on discretionary spending when they don’t actually have the money to do so.
With credit cards, there is literally a price to be paid if you don’t pay off the balance each month – with sky-high interest rates common, this makes it all the more difficult to pay off overspending.
Racking up big credit card debt is a problem for many people over Christmas, but it can have much longer ramifications than just the holidays.
Having multiple credit cards or high limits can be an issue for lenders who start to worry about your budgeting skills.
Of course, everyone should enjoy themselves at Christmas, while also trying to live within their means.
That way, you are giving yourself the best chance of securing good debt from a lender in the new year which can help transform your financial future.