Key Points:
- A mortgage can be one of your best wealth accelerators.
- There’s more than one way to grow your wealth with a mortgage.
- If you don’t use credit correctly, it can bury you.
Good Debt vs. Bad Debt:
Debt sucks! Well, not all debt. There’s good debt, and there’s bad debt.
Good debt can be used as a tool to help build wealth. It can also be used to increase income over time. Bad debt can leave you broke and stressed out.
Examples of Good Debt:
Example #1
Mortgage for an Investment Property (Real Life Example Purchased in 2019)
- Leverage is one of the most powerful tools to build wealth. You borrow money to purchase a property that will earn you income and appreciate over time.
- Your monthly cash flow on that property is a return on investment. Also known as your cash-on-cash return (numbers below).
- The property appreciates over time. Every area is different, but let’s assume it appreciates at an average of 3% per year. That’s 3% of the value of the property. Not the amount you have invested. That’s a 3% return that you’re not paying taxes on! Here’s a tool you can use to check appreciation rates: http://www.city-data.com/
- Your tenants are paying down your mortgage. That is also tax-free wealth growth!
- You’ll receive tax benefits through depreciation.
Cash-flow
- $250,000 Property Value / Fourplex / Each unit is 2 Bedroom & 1 Bathroom
- $67,500 Out of Pocket to Purchase the Property (incl. down payment and closing costs)
- $1,770 Monthly Mortgage Payment (incl. principle, taxes, and insurance)
- $5,125 Total Rent
- $3,355 Monthly Cash-flow
- $2,100 Monthly Expenses (incl. 10% property management, assume 7% for maintenance, assume 7% for capital expenditures, and assume 7% for vacancy, oil)
- $50,000 Renovations
- $117,500 Total Out of Pocket
- $1,255 True Monthly Cashflow / $15,060 Yearly = 13% cash-on-cash return
Appreciation:
- $335,000 10-Year Value based on appreciation / However, with the renovations and the current market, the property is already worth more than $350,000. I will assume that it appreciates at 3% over the next 7 years. Which would be $430,000.
- Remember, you put in $117,500, but the property appreciates at 3% of the property value.
- $130,000 10-Year Tax-Free Return on a 3% Yearly Appreciation Rate
Mortgage Paydown:
Loan Balance
2021 – $184,475
2022 – $181,311
2023 – $178,002
2024 – $174,541
2025 – $170,921
2026 – $167,134
2027 – $163,174
2038 – $159,031
2039 – $154,699
2040 – $150,167
$37,500 10-Year Tax-Free Return. The earlier years of a loan are heavily interest paid. As you get into the later years, there’s more principle paid down.
Your $117,500 investment in 10 years = $318,000 / Technically more than that if you reinvest all of the cashflow / If you use a 1031 Exchange at the sale of the property, a good portion of the growth is tax-free.
Example #2
Student Loans:
Another example of good debt is student loans. Now, here’s where I’m going to get some massive pushback. However, hear me out.
I’m not saying you should take on immense student debt with no plan. I’m also not saying that you “need” to go to college to succeed and make all your dreams come true.
I’m saying that taking out a reasonable, planned amount of debt for student loans could benefit you.
Not everyone has parents that can pay for their tuition. In fact, around 70 percent of students take out some sort of debt to pay for college. Some borrow more than others.
Like using debt as leverage, taking out loans to pay for school needs to be thought out and purposeful. Again, I’m not saying you need a degree to become successful, but I believe that the more tools you have in your toolbelt, the better off you are.
If you don’t have a college degree, there are a lot of jobs out there that you just won’t be able to get. Or maybe you can get them, but you’re going up against college graduates with similar qualifications otherwise.
Student loans can empower and drive you towards higher income if used properly. By all means, get creative to try and avoid student loans.
Examples of Bad Debt:
Example #1
Credit Card
- They come with high-interest rates.
- People often use credit cards to buy things that they can’t afford. My rule of thumb: If you can’t afford to buy it twice, don’t buy it.
- You can end up damaging your credit. This will hurt when you go to borrow good debt.
Example #2
Auto Loan
- It’s easy to overspend when you buy with credit.
- You end up paying more because of interest rates.
Most items that fall into the category of “bad debt” start losing money the second you buy them. That’s the opposite of building wealth.
This is where most people get caught on the hamster wheel. You use credit cards to buy the clothes and dinners you want and can’t afford. The toys that your kids want and don’t really need.
The list goes on and on. Notice all these things are “wants,” not needs? And don’t even give me that “Well, I needed the clothes” or “I need to eat.” Those items are necessities, but you don’t “need” designer clothes and don’t “need” to eat out. Buy off-brand clothes that you can afford and pack your lunch.
The auto loan is another one that I will get kick back on. You generally do “need” a car to get to work.
However, you don’t “need” a new car, and you definitely don’t “need” that BMW. I don’t want to hear it from the salespeople right now. “I need a luxury new car to look successful to my clients.” Stop! That’s all in your head.
I drove a 2010 Honda Accord until 2021 and ran it for 182,000 miles. For every one of those years, I was in my area’s top 2% of realtors. Not once did that car cost me business.
Honestly, I feel like a jackass showing up to clients’ houses in my new Tesla. The Honda wasn’t noticeable. It was just there. You don’t need to overextend yourself on an automobile. Get one that fits your current budget and run it into the ground.
The moral of the story is debt can be your friend or foe. It’s pretty straightforward. It’s up to you to not sell yourself on the lies of bad debt.
