Let's face it. I don't think anyone has ever had a conversation that started with, "My debt levels are super high and I'm pumped about it!". Debt has always been perceived as an evil, especially when you have credit card companies charging almost criminal interest rates of 20% annually. That is definitely BAD debt. This, compounded with the fact that the media is talking about record levels of Canadian household debt on a daily basis, you can't help but have a bad taste in your mouth where debt is concerned.
I grew up in a household with Greek immigrant parents and the old school Greek mentality that if you didn't have enough money to buy something, you simply didn't buy it. You NEVER took on debt. You waited to save up enough money in order to buy it. No doubt, many of us today would benefit from this simple logic. To this day, my 70+ year old mother has never had or used a credit card and has never leased or financed anything. After all, debt is a bad thing. Or is it?
I want to challenge the assertion that all debt is bad. More specifically (for the purposes of this article), when it comes to real estate investing, debt used properly can actually be a GOOD thing as long as you have structured it correctly.
With the recent run up in Canadian real estate, many Canadians now have a large amount of equity sitting in their principal residence. There are a couple of ways to access this equity:
1. Re-finance
2. Secured Line of Credit
Both options lead to new debt, however, if used to acquire a cash flowing investment property this would be considered GOOD debt. Why is considered good debt?. The answer:
1. The interest on the debt used to acquire the investment property can be used to offset your taxable income
2. The right investment property will have enough cash flow to service the investment debt, property expenses and mortgage payments and leave some cash at the end of every month.
3. The investment property offers mortgage paydown and appreciation over time.
The main distinction here between good and bad debt is that bad debt must be serviced by the borrower, negatively affecting their cash flow situation, whereas good debt positively affects the borrowers cash flow situation and helps to create long term wealth.
Obviously this is a very simplistic overview, but hopefully it is enough to get people thinking that all debt is not created equally. Used wisely, debt can be a very powerful tool towards wealth creation.
Paul Kondakos, BA, LL.B, MBA - Professional Real Estate Investor