Many people view debt as a bad thing, but if you use it properly, it can move you closer to your financial goals. Real estate investor and financial influencer Graham Stephan recently explained in an interview how he uses debt to build wealth.
"I have a lot of good debt," he stated in the conversation.
He expanded on what it means to have good debt vs. bad debt. The benefits of going into debt can outweigh the setbacks if you know how to use it correctly.
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You Should Make Money With Good Debt
Stephan defines a good debt as a financial obligation that allows you to earn more money than you spend. If you pay $3,000 per month in housing costs for a rental and collect $3,500 per month in cash flow, you have good debt.
Some real estate investors may argue that an asset that produces slightly negative cash flow is also a good investment since it builds equity, and you can raise rent prices over time to make the cash flow positive in the future.
This type of debt can help you build wealth faster than if you operated without debt. Good debt allows you to multiply money and leverage other people's money to improve your finances.
Have A Higher ROI Than The Interest Rate
Stephan explains that if you borrow money at 10% APR for your business and get a 50% ROI on the borrowed money, you are using debt productively. Stephan offers many examples that revolve around knowing the interest rate and generating a return that's higher than the interest rate.
Thinking in percentages makes it easier to distinguish the difference between good debt and bad debt. For instance, credit cards are a well-known example of bad debt. Consumers often get into credit card debt by making unnecessary purchases and rack up high interest rates in the process.
If you need to borrow money for a business expense, you're better off avoiding high balances on credit cards. The APR on most credit cards ranges from 19% to 29%, depending on your creditworthiness and other factors.
See Also: Many are using retirement income calculators to check if they’re on pace — here’s a breakdown on what’s behind this formula.
Smart Tax Write-Offs
Stephan also mentions that if you have a 6% interest rate on a car that produces a 10% return since it's used for business, you can treat it as good debt. However, cars have an additional perk. If the car is a business expense and qualifies, you can deduct a portion of your car's value from your taxable income during the first year.
This accelerated depreciation schedule can free up more capital and boost your overall return. You will have to make monthly auto loan payments for a while, but you can trim your tax bill considerably when you buy the vehicle. This write-off is mentioned in Section 179 of the IRS tax code.
Some people don't mind paying a 6% interest rate on an auto loan if they can use depreciation to make less of their income taxable at their highest tax rate. Real estate is another asset that enables many tax deductions on top of the potential returns you can realize by renting your property.
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