Investment property loans can be a good debt strategy to build wealth. But did you even know there is ‘good debt’ and ‘bad debt’? If not, let’s read about the difference and how to use one (and eliminate the other) to get to financial freedom.
What is good debt?
Good debt is just debt that makes a return for you (after the cost of holding that debt). It’s borrowed money that you use to invest in an asset that will appreciate in value or pay you an income – ideally both!
An example of good debt is an investment property loan. Other examples are business loans and partnership loans.
Bad debt is borrowing to buy items that lose their value over time.
An example of really bad debt is credit card debt that you don’t pay back in full each month. Credit card interest is some of the highest going around. It’s definitely one of the first types of debt to eliminate, if you have it and are not paying it off in full monthly. Other examples are afterpay loans, car loans and personal loans.
Slay the ‘bad debt’ dragon
If you’re starting your financial freedom journey with a lot of debt you’re not alone. It can often be the crushing weight of bad debt that really drives people to make a change to their finances and their life. And we are big believers that regular folks in this position can turn things around by taking control of their finances. We are here to say that there’s definitely a pathway out of debt for you!
Once you get on this path, the discipline you develop will not only help you slay the bad debt dragon, it will also help you become a great investor.
The best ways to eliminate debt
There are a two different ways to approach getting out of debt:
- the snowball method – paying off your debt from smallest to largest balance
- the avalanche method – paying off your debt from highest to lowest interest rate
The snowball method is thought to have the strongest effect on your psyche, in terms of your incentive to eliminate debt. This is because it’s easier to see progress along the way. You actually get rid of some individual debts early on and the momentum is supposed to snowball.
The avalanche method is mathematically the method to use if you want to pay as little interest as possible. But you need to be inherently disciplined and have a long term view because your progress may not be as clear as it appears with the snowball method.
It’s going to sound a bit nuts, but if you want to give yourself the best chance of succeeding, pick the one that most suits your personality type.
Ride the ‘good debt’ dragon
For some folks, the word ‘debt’ might inspire fear and panic. Sleepless nights. That kind of thing. For the rich 1% however, good debt is a core wealth building strategy. Ever heard of OPM – Other people’s money?
The rich use other people’s money to leverage their own capital and invest in assets that will appreciate over time.
The game is to use as little of your own money as possible to buy assets and then take advantage of tax minimisation strategies. Because they use leverage, the rich can invest in assets and achieve returns that are way higher than they would achieve with their own money.
The rich 1% are not fearful or panic stricken when they hear the word ‘debt’. The more ‘good debt’ they can safely take on to buy assets, the better. They understand and use risk management strategies to hold this debt. If you are clever with debt, it can really be the rocket fuel to your financial freedom plans. So if you want financial freedom, consider getting comfortable with the term.
How to get access to ‘other people’s money’
To borrow money from banks or private lenders, you need a few things in place:
- A good credit score
- Some of your own capital
- A good asset to invest in
Let’s talk about each…
Your credit score
You need a good credit score to borrow money from any financial institution. Make’s sense right? You have to demonstrate to them that you are financially responsible with their money. So what’s a good credit score and how do you go about getting one?
If you’re in the US, you’ll probably have a FICO score. The Australian system uses similar ratings to FICO, which are:
- 800 and above — Excellent
- 740-799 — Very good
- 670-739 — Good
- 580-669 — Fair
- Below 580 — Poor
To borrow money for investments, you’re aiming for a rating of ‘Good’ or above.
Tips to improve your credit score
- Establish a steady income paid into your bank account.
- Put some bills in your name and pay those bills in full, on time. The same goes for personal loans.
- Get a low limit, low interest credit card and pay it down each month
- Don’t use all of the available credit on your credit card. Stick to less than 50%.
- Check your credit history and credit score once a year.
Your own capital
This comes down to both making and saving money!
Check out this page where we talk about how to save, the saving rate you need to really get ahead with your finances and the best saving apps and hacks.
There are LOADS of different ways you can generate income nowadays. There’s earned income, rental income, royalty income, capital gains, etc, etc. We work on building multiple income streams – every dollar counts! We also think the best type of income is where you’re not directly trading time for money. So here you can find all of our ideas for making passive income!
An asset to invest in
Remember we said that an asset is something that puts money in your pocket at the end of the month? Well, not all investments are assets if you get my drift. The critical part of making the most of a good debt strategy is selecting the right asset to invest in.