Real Estate Investors Association of Greater Cincinnati

Good Debt, Bad Debt


Every day I meet people at a stage of their lives where debt is greatly affecting them. They are beginning to realize that debt takes much more than just your money.  

I am talking about people with average salaries—and people making good money or even exceptional money, but not necessarily making financial progress. These are good people, people that deep down know there is a better way but never seem to find it.  

When I refer to Good Debt, I am actually using shorthand meaning “good uses of debt.”  Debts, like guns, are actually neither good nor bad in and of themselves. In both cases, it takes a human to pull the trigger. When we sign, scan, or otherwise acknowledge indebtedness, we are pulling the trigger. It is how we use debt, and what we use it for that makes it good or bad.  

Using debt without considering value of the goods, services, or property being acquired is the beginning of serious trouble.  

Using debt wisely can increase your wealth, net worth, and cash flow. Using it poorly decreases or destroys these things. Never using debt at all is also a waste of resources—sure, you can use your available cash to invest in your future, but you’ll never get the leverage that good use of debt can provide. 

Let’s take an example that everyone can relate to investing in your own home. You could avoid debt altogether by waiting until you had $150,000 or more all in one pile, then pay cash. But how long would that take? And what would you be giving up in the meantime by paying rent for years and years, and missing out on the appreciation in real estate during the time it took you to save the money? Or you could use debt badly by financing your new home at 125% of value, and using the excess to pay off your credit cards so that you could run them up all over again. By piling bad debt on a good asset, you’d set yourself back years in terms of the equity in your home. A good use of debt would be to buy the home with a standard mortgage and build equity over time through appreciation and mortgage pay down.  

The fact is, when you examine the practices of the businesspeople who have changed the world, they’ve done so with the use of good debt—and by avoiding bad debt. They use debt to invest in opportunities with a reasonable margin of safety—just as we do when we purchase a piece of real estate at 70% of value and finance the purchase price. 

The problem that most Americans have is that they treat all debt as if it were the same. They get in trouble because they don’t practice “the 3 D’s”— Discipline, Deferral, and Discernment. Instead, they rely on “the 3 I’s”— Indifference, Immediacy, and Ignorance 

We are trained by our culture that we need a lot of consumer goods that decrease in value the second we buy them. We are also told that we deserve them NOW (immediacy), that it doesn't matter how much they cost, as long as the payment is affordable (indifference), and that we don’t need to examine the long-term effects of the debt we take on (ignorance). We are encouraged to accumulate “stuff” instead of wealth. And this “stuff”, that decreases in value over time, ends up costing us greatly in terms of financial independence, freedom, and, ultimately, satisfaction and happiness. 

Learning to get away from “bad debt” entirely is as much a key to your success as a real estate entrepreneur as making good deals. So, following Moses’s cue, here are my Ten Commandments of Debt Management 

Thou shall stretch your financial lifetime perspective. If you are forty, planning for forty more years is not excessive. Don't outlive your money. 

Thou shall not be beguiled by mass media, advertisers, or the merchants of debt. Work your plan, not the plan that others have for your life. Instill the discipline in yourself to stop buying things you don't need, to impress people you don't know, with money you don't have. 

Thou shall make income run ahead of expenses. In short, spend less than you make 

Cars are commodities, not investments. Work to position yourself so cars are cash purchases. Buy less car, drive it longer, and set up a sinking fund for the next one.  

Thou shall not allow your Burn Rate to exceed 90 percent. Your spending determines your ending. Live on 90 percent or less of your income. After you dump the debt, save at least 10 percent of your income. 

Financial Freedom is found in submission to proven fundamentals. Forget the fads and secrets to wealth. Financial success is found in simple math, tried and true investments, and accumulation.  

Thou shall not borrow for consumption. Wealth is gained through accumulation, which is the opposite of consumption. If you can’t pay for consumer goods with cash, you shouldn’t buy them. 

The way to financial freedom is delayed gratification. Truly we should see delayed gratification as a blessing and not a curse. If you will live for ten years like most people are not willing to do, you can eventually live most any way you wish. 

Most of your happiness will come from relationships with people, not money and “stuff”. You really, really don’t “need” the latest and greatest widget. As long as you have family and friends that support on love you, you can be happy living in a cardboard box. Really. 

In general, use debt only for: real estate, education, and business. Not all debt in these three areas is good debt. To be classified as good debt, the real estate, education, or business must return the capital, pay the interest and still have a profit. Debt that meets these 3 criteria, though, will help you reach your dreams and goals throughout your life.  

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