Many would say that all debt is bad but in my opinion it most certainly isn’t
Good debt could be for school fees or setting up your new business, buying your home or investment properties. If it is creating something, or paying for growth it is good as long as you can afford it.
We need to look at what we get for the debt. If the debt you take out helps you generate income and build your net worth then that can be considered positive. So too can debt that improves your and your family’s life in other ways. Sometimes it will be financial reward, i.e profit (where we are making more money than the debt is costing). Good debt is often exemplified in the old adage “it takes money to make money.”
Sometimes it will a roof over our heads that is giving us a home. Debt is not always bad just because it doesn’t give a profit back as long as the reason is beneficial and worthy of the cost.
Bad debt isn’t all that difficult to spot. If it loses value the moment you take ownership, it’s bad debt. Unfortunately, that describes many of life’s basic necessities, like clothes, cars, and the bells and whistles TV. This doesn’t mean we shouldn’t have some bad debt but we have to be careful to have no more than we can afford to pay for. And ideally make sure that you have good debt as well. Understand that where you have bad debt (or any debt in actual fact), if you make repayments on time, debt can also work as evidence of good financial planning and responsible borrowing and give you that all important high credit score.
Let me give you an example of a deal (slightly changed) that I was part of. Here the debt was already serving a purpose by creating a home but we could see a way of turning it into inexplicably Good debt.
The home was worth £250,000
£250,000
It had no mortgage so there was a peace in knowing there was nothing in the future to fret about.
BUT was it working hard enough, some would say yes because it is giving a home and security – and that is why there is definitely an element of truth in it being Good Debt already
But here is an alternative scenario
Let’s assume we could get 100% mortgage (just for ease of maths) so we now have £250,000 in cash to invest.
We go to Reading and buy 10 flats all worth £100,000 each. We pay the deposit of £25,000 (25% LTV) and we get a 75% mortgage (=£75,000)
So we’ve used all our money up. £25,000 x 10 = £250,000
What would that DEBT give us.
Let’s assume each flat generates £800 revenue a month. The mortgage of £75,000 costs £300 so we have a profit of £500 per flat. We have 10 flats so we have £5000 profit per month
Now lets assume that the house doubles in value over 10 years
10 Years
£250,000 £500,000
It is fare to say that the 10 flats that you bought for £100,000 each also double in price,
Which means you have £1million pounds worth of equity (without debt)
At the 10 year point you decide to sell 2 of them at £200,000 each (remember they’ve doubled in price)
You pay off your home mortgage of £250,000 leaving you with a debt free home and £150,000 to spend or reduce your further debt.
The end result therefore is No mortgage on your own home that now values at £500,000 plus 8 properties valuing at £200,000 each = £1.6m of which you have £800,000 equity (unincumbered / no debt)
= £1.3m (£500,000 + £800,000) of equity and £600,000 of income
Whereas if you leave your house with no mortgage, after 10 years you have £500,000 worth of property but no income.
SCENARIO 1 SCENARIO 2
£500,000 of unincumbered property £1.3m of unincumbered property + £600,000 of profit banked
Scenario 2 shows exceptional use of money /Good debt by creating a home whilst also generating income and building your net worth.
I have met many people, who even in the financial sector do not understand the difference between good debt and bad debt. Once people have an understanding of the two, they will find fear of debt ebbs away and the new found clarity together with diligence, allows DEBT to serve them well.
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