Posted on July 4, 2022
Good Debt Vs Bad Debt
Good Debt Vs Bad Debt
Most people don’t understand debt. Most debt is bad and I understand where people are coming from when they say, “I want to invest but I don’t want to get into debt.”
When I hear this statement, and believe you me, I’ve heard it many a time, then I know the person has little understanding of the monetary system we live under, how interest is calculated and tax benefits and incentives available to investors.
I also understand that any decision they make is based on fear, fear of losing everything.
..and for them, the only solution to investment is through savings.
I congratulate anyone who is able to save, if they have no debt. If they own their home and they are saving for an investment, then I couldn’t think of anything so misguided.
A simple analysis of the effective interest earned from savings after tax is enough to scare anyone from doing it. We’ll take a closer look at this in a second.
If there are other debts, e.g. credit cards, car loans, mortgage debt and they are saving, then again, someone is not thinking straight.
Simply look at the interest paid on debt compared to interest earned on savings after tax. They will never be the same and interest on debts will always be higher. So why do it? That money saved should always be channeled to paying non tax-deductible debt.
This brings us back to saving for investment purposes due to fear of getting into debt.
A good understanding of what bad debt is and what good debt is will help us manage our decisions a bit more wisely.
Mortgage debt on a Principle place of residence (PPR) is regarded as being bad debt. You pay interest on the loan. The longer it takes to pay the mortgage, the more the PPR will cost you. Just look at the statements for loans over 30 years. You end up paying more than double.
Your major goal should be to reduce this debt as quickly as possible. It’s non tax-deductible either. Same goes for car loans, personal loans and credit cards.
Enter good debt.
Good debt is money borrowed to buy income producing assets that grow in value over time. In property investment, any interest I pay on the loan becomes a tax deduction. This is what makes property investment so exciting. This is debt that works for me.
As property is a big ticket item, saving for a deposit can take a long time. This is time wasted because property will increase in value over this time. Your dollars saved will decrease over time due to inflation.
People who decide to save because they are fearful of going into debt are not doing themselves a service.
If your PPR is paid off, you will have plenty of equity to be able to borrow the deposit and costs. This becomes part of the investment and the interest paid is fully tax deductible, just like the rest of the investment loan.
If your PPR is only partially paid off, then you can begin to use the extra cash flow generated from the good investment debt to help you pay down the bad PPR mortgage debt.
If you want to find out how, simply contact us at Property and Finance Solutions and a consultant will show you how.