What Everyone Should Know About Debt

Question

Good debt vs. bad debt

Debt doesn’t have to be a bad thing. Taking on some debt might allow you to achieve your goals or fulfill your dreams. Borrowing money can help you complete your education, purchase a home or fund your small business. Other kinds of debt could simply be necessary, like borrowing to cover an unexpected medical expense.

Mishandled debt, however, can become a serious financial and emotional burden. Debt turns bad when it is made up of loans that you cannot repay. And it gets worse when you accrue high interest and/or fees that exceed the value of your purchase. Bad debt might also include loans from questionable sources, like payday lenders who may offer quick cash at terms that are disadvantageous.

Before you get scared off by learning about debt, consider this: Understanding debt and planning for your financial future helps you be mindful of your money. Your core values will guide your approach to money management. If you budget and track expenses, you’re taking time to plan for what you value most. You’ll also be more likely to recognize situations in which you might overspend; special occasion spending like travel, birthdays, graduations or anniversaries, for example.

In other words, learning how to manage debt comfortably and when to pause before borrowing can help you enjoy the opportunities that good debt can provide while avoiding bad debt pitfalls.

Evan Polaski · Answer

@Tariq Hakeem, there is a reason why many in the financial world do not use debt and leverage interchangeably.  Of the financial planners I know, and many real estate investors, you can change good debt to leverage and bad debt to just debt.

I know it is semantics, but in order to fit in with the general population's way of thinking, changing the naming can have a powerful effect.

Karl B. · Answer

Agreed. If it wasn't for debt most of us wouldn't have been able to invest in real estate and debt has helped many of us grow much faster than had we been forced to cash buy.

That's why I laugh at Dave Ramsey; for as we know all debt is not created equal.

I think debt can be scary to a R.E. beginner but if the deal has good numbers that make sense debt is simply a vehicle to be able to purchase.

It amazes me how many Americans have bad debt. I have a friend who has credit card debt from buying meals from restaurants and things he doesn't really need. And his credit card charges roughly 25% interest and so he's throwing his money away on paying interest.

I've never paid a cent of interest. I didn't have a credit card until I was 31; I got one because I was super embarrassed I had to get my dad to co-sign an apartment because I had had no credit - up to that point I had paid everything in cash/check/Paypal because I'm super old-fashioned.

A year later when my lease ended I purchased a home cash and I admit it was a bit scary to get a loan on my first rental property but if it wasn't for that loan I wouldn't have owned the property so YAY, DEBT!

Tariq Hakeem · Answer

@Karl B. That is so awesome man! Very well said as well!!!

Joel Florian · Answer

@Tariq Hakeem

After being a diehard Dave Ramsey fan for 15 years, I moved to Oahu Hawaii.   Anything we could afford to buy with cash would have been an hour from my work and in a neighborhood my wife would refuse to live in.   So I started considering getting a loan. I also got advice from biggerpockets members.   I decided to rent in Hawaii and buy rentals in Alabama.   Turned out to be a good decision because  the HI project got terminated.

Meanwhile we got introduced to the bank on yourself comcept.  Where you basically transfer all assets to cash value life insurance policies and borrow against the cash value to buy properties and make downpayments.

Joel Florian · Answer

@Karl B.

You may laugh at Dave Ramsey, but it is possible to buy RE with cash.

I am a case in point.   I wanted RE and passive income but I barely had any savings.  Single wage earner with a Bible degree and a wife and 3 kids.

First I bought an acre at a tax deed sale for $6500.  Sold it on installments for $12,000.

Then I got laid off and hired in with a new company--this released retirement funds that were paid out over the next 3 years.  I opened a solo401k to receive the $75k.  As the 401k got funded, I purchased small RE notes.  I also sold our home of 10 years and got about $30k.  I purchased 33% of a contracting business with the 30k proceeds and money I borrowed from the 401k.

Since it is a Solo401k, I feel like it is different from borrowing from a bank.  I am essentially borrowing from my retired self (or selling 401 a note).  I also purchased a home for $125k owner finance -- put down $25k (borrowed from 401k) 6% with 15 year amortization and 5 year balloon. 5 years later, I sold my shares of the business.   While I was waiting for the $220k payout from the business, I borrowed from my 401k again and bought a flip.  A year later, received $220k from the business $35k profit from flip, and $300k from sale of home (which was another live in flip).  Then purchased a turnkey property in AL.  And purchased and renovated a house in AK which we converted into a duplex for STR.  Full disclosure, I also lost about $25k trading futures.

Tariq Hakeem · Answer

@Evan Polaski

Agreed!!!

What Everyone Should Know About Debt

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