Is All Debt Bad?

Many of us have been told from a very young age that debt is bad and should be avoided like the plague.

Is this true?

Just like with everything else, it depends.

Debt can be a great way to build wealth at a faster pace than saving up cash for everything. It can also be a quick road to ruin if you misuse it.

So how do you know if you are on the right track?

First you must understand what assets and liabilities are.

Assets vs. Liabilities 

The simplest way to distinguish between assets and liabilities comes from Robert Kiyosaki. He says that assets put money in your pocket and liabilities take money out of your pocket.

For example, let’s talk about your personal home. The home that you own and live in is not an asset. It does nothing to put money in your pocket (unless you sell), while every month you are paying a mortgage, taxes, utilities, and repairs. Let’s compare that to the cash flowing rental home that you own. As long as you are bringing in more rent than your expenses, this is an asset. Every month you are receiving rent that is paying down your mortgage, covering the other expenses, and putting money in your pocket after that.

We are in no way saying that you should never buy a house, just be sure you realize it is a liability and there is no guarantee that it will appreciate in value.

Bad Debt

Bad debt consists of the things that take money out of your pocket.

Some examples are vehicle loans, mortgages on your residence, credit card debt and other consumer debt. The problem with this debt is that it can never pay for itself, and usually the value of these items will depreciate over time (homes CAN be an exception). I am not saying that you should never buy homes, cars, or any other consumer items with debt. What I am saying is that you should be conscious of what it is you are buying, and decide if you can actually afford what you are wanting to purchase.

Using debt to purchase these items can help improve your overall cashflow if you can get good terms from the lender, and allows you to use your cash for buying assets to pay for these items.

Good Debt

Good debt puts money in your pocket. Using other people’s money (OPM) to buy cash flowing assets is what we would call good debt.

This type of leverage can greatly increase your return on investment (ROI). I will show you an example of using cash and using debt to purchase a rental property. This example can be applied to other types of asset purchases, it is just easier for me to illustrate this to you using real estate.

*I realize there are things like closing costs, taxes, insurance, vacancies, repairs, capital expenditures and utilities which haven’t been taken into account.  This is just meant to demonstrate how using good debt can be beneficial.

1. The first example shows buying a rental property with no debt. Notice that there is no loan expense, but all of your cash is tied up in the property. The return on your cash in this example is 12%. You are taking $100,000 and turning that into $12,000 of positive yearly cash flow.
2. In the second example you are buying the same $100,000 property, but are using a loan to finance 80% of the deal (so you only have $20,000 in the property). Your yearly net cashflow is $6,780, that is a 34% return on your cash in the deal! (6,780÷20,000)=return
3. The last example really shows the power of using OPM. Instead of putting all of your $100,000 into a single property, you decide to buy 5 $100,000 properties and put 20% down on each. This leverage turns your $12,000 annual net cashflow from example 1 into $34,000 net cashflow. Using leverage increases your cashflow by 280%!

What About Debt in Your IBC Policy?

Is a policy loan good debt or bad debt?

That depends on what you are buying. Just because you are your own banker now and controlling the flow of money in your personal economy doesn’t mean it is smart to buy things that you ultimately cannot afford. Here are some important things to remember when utilizing policy loans. 

1. When you borrow from your policy you are in total control of that debt. You can decide when to pay it back and how much each repayment you make is. 
2. You are paying interest to the insurance company but are still earning uninterrupted compound interest on the cash value (you are not losing opportunity cost), allowing you to keep all of your money working for you.

Just because you can buy something does not mean you can afford it.  

That goes for paying cash, using financing, or your IBC policy.

Ex. When purchasing a car many people look at the monthly payment to see if they can pay it. These loans can extend past 5 years now! By the time you get the vehicle paid off, you will not have had any time to save up capital. You will be right back at a dealership looking for another vehicle, perpetually stuck making a good living for the car dealer, and a great living for the banker.

Take on the responsibility and learn the discipline required to become your own banker.

Exercise your rights to policy loans and other debt with caution, and when effectively used, you can reach your path to financial independence sooner!