Good Debt and Bad Debt

Using Debt as Positive Leverage:

The following is an online conversation between an investor who feels that being debt free is the only way to invest. Some people feel that paying off all their debt and mortgage is the way to financial prosperity. 

Many Financial Authors also push this debt free mantra (Suze Orman, Dave Ramsey, and John Burley) the thinking is that if you have no debt and live frugally you will be comfortable in retirement.

 There is also another way, a way that myself and many others subscribe to. It actually increases your retirement income exponentially and provides a far greater lifestyle that living frugally in your retirement years.

The Secret is Leverage.

In the example below you can see how debt used properly can explode your investing and retirement.

Russ is a real state investor and owns a Bed and Breakfast in Napa,CA

 
Robert Kiyosaki differentiates between bad debt-- stuff that takes money OUT of your pocket (a car loan, credit cards, personal home mortgage, etc), and good debt-- stuff that puts money IN your pocket (say, a home that you own and rent out, and get $150/mo profit after paying the mortgage, taxes, and upkeep).

When we first got started, we were very anti-debt. We had 2 homes- one we lived in, and the other, a fixer-upper. By 2002, my plan was to sell one house, and with the money I cleared, pay off the other house's mortgage entirely. We'd invest what was left after paying off the mortgage, and live off the interest. In other words, if I cleared $500K when I sold the first house and paid the house I was living in off for $135K, I would have $365K left to invest. If I invested the $365K in interest-bearing Treasury bonds (say, at 5% per year), that would give me $365K x 5% = $18,250 per year to live on, for the rest of my life, without touching any of the $365,000 principle.

That was my plan, based in large part on what I'd learned from folks like Suze Orman and Dave Ramsey. This way, once I sold the house, my money would "work for me" (to use an RK phrase), and give me enough to live on. Since my house would be paid off (all of my cars and everything else was already paid off), I could easily live on $18K per year.

So, my plan was to have NO DEBT by 2003, and have $18,000+ coming in, while I kicked back and did nothing.

Sounds pretty sweet, eh?

But then our lives changed. We read Rich Dad Poor Dad, and started playing the Cashflow game . . .

Here we are 4 years later from our original 2003 "retirement" goal. We are *not* retired (still working-- lots), and have LOTS of good debt (over $3,000,000.00). The properties we own with this good debt bring in over $700,000 a year before expenses, which pays for the debt payments.

If we sold EVERYTHING today, after paying off all of that good debt, we'd have about $4,000,000.00 before paying off the realtors and income taxes.

Or, about $3,000,000 after these expenses.

$3,000,000.00 x 5% Treasury Bonds = $150,000.00 per year.

Seems a little bit sweeter than $18,000, eh?

But we aren't going to cash out-- not yet.

Based on some of Robert Kiyosaki's other principles, we're adding value to one of our properties, and will sell things in another 5 years or so.

At that point, we'll have about $5,000,000 after sale expenses.

$5,000,000.00 x 5% = $250,000.00 per year income, while we sit around and just have fun.

The above scenario is one of the things we learned by playing cashflow. We learned how to handle good debt, and how to get rid of as much bad debt as possible (e.g., we currently have no car loans or credit card debt).

But we do have lots and lots (and lots) of RE mortgages-- over $3,000,000.00 worth. That good debt helps us get over $700,000 a year-- before expenses. And within 2 years, we should be bringing in well over $1,500,000.00 before expenses, since we're developing that other property.

This is just one example of how "good debt" can really work for you-- and put you WAY ahead of the game-- using leverage.

There are many others on these forums who are doing the same thing-- with different strategies, and different properties or investments. But all of them center around "good debt".

Hoping this makes sense . . .

-Russ H.