The Difference Between Good Debt vs Bad Debt and What Really Builds Your Net Worth

 

When people think about building wealth, they often focus on how much money they have in the bank or how quickly they are paying down their home mortgage.

Both are important, but they don’t necessarily tell you whether your overall wealth is growing.

Your net worth is the value of everything you own, less everything you owe. So, when you’re thinking about your financial future, an important question to ask is not only,

“How much debt do I have?” but, “what is the value of my portfolio?“

This is where understanding the difference between good debt and bad debt can help you make more strategic financial decisions, and develop a growth mindset for your long – term wealth creation.

What is good debt?

In simple terms, good debt is debt used to purchase an asset that can do two things – generate income and potentially grow in value. An investment property is a good example.

You borrow money to purchase an asset, your tenants contribute rental income towards the cost of holding it, and if you’ve selected a quality property, historically, it will increase in value over time.

There can also be tax advantages associated with investment property expenses. Interest and certain other eligible costs may be deductible against your income, depending on your circumstances and whether you choose a new-build or established property. Having said this, it’s more important to buy a property for its long term benefits than tax benefits.

Tax deductions should be a secondary benefit. Your primary goal should be wealth creation through quality assets and capital growth, and tax benefits can change at any time.

What about bad debt?

At Property Consulting Australia, we think of bad debt as debt that isn’t helping you create income or build wealth.

Credit cards, personal loans and consumer debt are obvious examples. You pay interest on money you’ve borrowed to purchase things that may quickly lose value and don’t produce an income.

Your home mortgage is slightly different. Your home may grow substantially in value, but it doesn’t produce income while you’re living in it, and interest on your owner-occupied mortgage is generally not tax deductible.

That’s why one of the long-term goals for many of our investors is to use wealth created through their investment portfolio to help reduce their home mortgage and ultimately become debt-free.

Example: $500,000 of debt isn’t always the same $500,000

How can I use $500,000 of good debt?    

This is where property investing can be an excellent wealth creation strategy. Imagine you borrowed $500,000 to buy an investment property five years ago. 

An investment property purchased in a good location would now be worth closer to $700,000 – providing you with an uplift of $200,000 in equity (considering 8% growth per year).  What could you do with an extra $200,000?  The longer you can hold this property, the stronger your net worth in the future.

As the property grows in value, the debt now represents a much smaller proportion of what you own.  Inflation means that $500,000 today doesn’t have the same purchasing power it did five years ago, so while your asset is increasing in value, the debt is reducing in value. At the same time, your rental income is likely to increase. Win – Win.

Even if you are paying “interest only” on the loan, the dollar amount of the loan may not have changed, but your equity and net wealth is growing in value. 

That’s one of the reasons capital growth is such an important part of our investment strategy at Property Consulting Australia. Our research focuses on finding quality properties with both strong growth potential and healthy rental yield. And the proof is in the results – we’ve achieved an average capital growth of 14.8% per year over the past ten years, compared with a national average of 6.4% per year.

Paying down debt vs building assets

There is nothing wrong with steadily paying down your home loan. For many Australians, it’s an important financial goal. But imagine spending the next 15 years putting every available dollar into your mortgage compared with building a portfolio of quality assets, which you can do alongside paying down your mortgage debt.

Those assets have the potential to grow in value and produce income while you continue working. Over time, the equity you build may give you more choices – including the opportunity to reduce your home mortgage, fund your retirement, help your children or leave a legacy for your family.

And eventually, it’s your assets that can help pay for some of the luxuries you want to enjoy.

Let us help you make your debt work towards your future

The goal isn’t to accumulate debt for the sake of it. It’s to use debt strategically.

At Property Consulting Australia, we help everyday Australians understand how property can form part of a long-term wealth creation strategy. We look for quality properties with high capital growth factors and strong rental demand, while considering your cashflow, borrowing capacity and personal goals.

If you’d like to understand how property investing could help you grow your net worth and work towards reducing your home debt, please give me (Patricia) a call 0434 369 003 or email me at [email protected]. Let’s start with a free 15-minute strategy consultation.