What Is Good Debt? - Building Wealth Using Debt As A Tool

Assets put money in your pocket, whether you work or not, and liabilities take money from your pocket.
Robert Kiyosaki

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Risks vs. Rewards Of Debt

If you’ve read My Story or spent a lot of time on this site, you may be a little confused to find an article about building wealth with debt. Fair enough.

And honestly, you should be.

In My Story I make a clear mention of an income earning rental property I once owned with a mortgage. My wife and I moved into that rental and sold our primary residence. We did all of that in the name of paying off debt.

And yet, here I sit. Writing an article about using debt to build wealth. In fact, calling some debt “good debt.” Let me explain…

“Good Debt” At A Glance

Let’s assign “good debt” a clear, simple definition.

“Good debt” is any debt that helps grow your net worth over time.

A simple example might be refinancing a rental property (Property A) to pull out some of the equity in order to purchase another rental property (Property B). If you do this correctly, the tenants in Property A will still cover the monthly cost of mortgage and management, and your new tenants in Property B will do the same.

Any extra income from those properties can be used as you see fit. If you’re growing your real estate portfolio, you may choose to funnel all the extra back into Property A again so you can do another refinance later, pull out the equity you’ve built up, and buy Property C.

And on and on it goes…

So, in theory, this “good debt” is “good” because you are using it as a tool to actually increase your net worth. (You wouldn’t purchase a property using this method that didn’t have immediate equity. You would shop for deals.)

Another example might be a business loan on a successful business.

If you wanted to get really technical, you might say that mortgage rate on your house is a good debt even if you could pay it off so long as you have investments with a rate of return that beats the interest rate on your loan.

Basically, the definition of “good debt” is only limited by your creativity. If you get imaginative enough, you can justify just about any debt. And that’s the issue…

The Truth About “Good Debt”

My next statement will be something just about everyone can agree on. Following that, it get’s heated.

The truth is, debt = risk.

Let me take my previous real estate example again.

This time, let’s say you have a mortgage on your house on top of the three mortgaged rental properties. Keeping the math simple, let’s say each of your rentals cost you $750 a month ($2,250 total) but brings in $1,000 ($3,000 total). Great. You clear $750 per month!

But what if your tenants move out of Rental C? You still owe $2,250 on your properties, but now you’ve only got an income of $1,500. Now instead of being up $750, you’ve got to find $750. And you’ve got to keep your own roof over your head on top of that!

See? “Good debt” is only good when everything, and I mean everything, works exactly as planned. One hiccup in the plan can bring the entire house of cards down.

Strong Opinions

Now before you hit the comments:

Yes, the example above represents a tight situation mathematically that an experienced real estate investor probably wouldn’t put themselves in. (But, are YOU an experienced real estate investor?)
Yes, an experienced real estate investor probably has some cash on hand to cover vacancies. (How many months could YOU cover comfortably?)
And yes, people have used this type of leverage successfully and will continue to do so.

But, I stand by my statement. Debt, no matter how “good” it’s intentions, invites risk.

If this is a path you want to go down, I expect at some point you will be doing some serious mental gymnastics to justify your choices. And I sincerely hope you’re successful.

Personally, I’ve tried it. The security I have now far outweighs the benefits I had before.

Either path you choose, remember: Regardless of your money goals, you can “Bank on a Budget” to get you from where you are to where you want to be!

“Debt is dumb. Cash is king.”
Dave Ramsey

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Alex

Hello, my name is Alex! I'm a public school teacher who has achieved some big financial goals just by getting control of my money using some simple strategies like using a monthly budget. Now I'd like to share what I've learned with you. Welcome to "Bank on a Budget!"