How much debt should a person incur? That completely depends upon what type of debt is being considered. If good debt is the center of your focus, my answer is “as much as possible.” Conversely, bad debt should be minimized as much as possible. You may be saying to yourself, “Good debt? There is a kind of debt that is good?” Most certainly. Let’s start out by clearly defining the difference between good debt and bad debt. Then we will discuss turning bad debt into good debt.
Bad debt is any balance you incur that does not yield a positive income. Examples of this would be the mortgage on your home, your car payment, and credit card balances. Good debt is any balance you incur that yields a positive income. Examples of this would be investment property and a loan for a business. Basically if you enter into a contract for payment of something over time and it is costing you more money than you receive from that item, it is bad debt. Notice that I am using the word debt and not expense, there is a difference.
When referencing turning bad debt into good debt, a more accurate statement would be, “Pay for your expenses incurred through bad debt with assets acquired through good debt.” But that statement was too long for a title. So just exactly what do I mean by all of this? Let’s use an example to illustrate my point. For the purpose of this example, let’s say that you want to purchase a new home entertainment system that you will use strictly for the purpose of the enjoyment of watching movies and listening to music in your own home. You plan on purchasing a 52″ LCD TV, ear bleeding 5.1 surround sound system, Blu Ray player, cd disc changer, etc. This home entertainment system is going to cost you $10,000. You do not have $10,000 in your checking or savings account so you do what every other American has been programmed to do, Charge It. They offered you a zero down, no interest for 60 months, because it is deferred, payment plan. As long as you pay this off within 60 months, you never pay a dime in interest. Sounds great right? As long as you are disciplined enough to pay it off, you end up using someone else’s money, for 5 years, for free. Now, assume that month 61 rolls around and you have not paid it off. No problem right? 22% interest is incurred on the remaining balance. Wrong! Interest is calculated form day 1. Total interest on $10,000 for 60 months at a 22% interest rate is over $6500. That’s right. You end up paying more than $16,500 for that home entertainment system. Not such a bargain now is it?
So, how would we change this situation to turn bad debt into good debt? Or more accurately, pay your expense incurred through bad debt with assets acquired through good debt? Use a little creativity and the solution becomes clear. First, we need to determine what type of asset we would like to acquire. I wrote about acquiring real estate with little or no money down so let’s use real estate as our asset. Prior to making your multimedia nirvana purchase, you talk to your real estate agent. If you do not have one by now, you need to seek one out and interview them to find a fit with your investing style. Don’t have a style yet? Then find someone you get along with and will gather the information you ask for. That’s a good start. I digressed. Contact your real estate agent and let them know that you are looking for an investment property. The bad debt you are about to acquire will cost you $167 per month, at the terms listed in the previous paragraph, to ensure that the debt is paid off in the time allotted. So, for the purpose of this example, we’ll assume that the property has the sole purpose of covering your impending bad debt transaction. After doing your due diligence, you find a small, single family home, with 2 bedrooms and one bath, in a middle class neighborhood. The home was owned by a little old lady who decided to retire to warmer climates. So there were no kids and the house was taken care of. She is selling you the house for $40,000. Using the principles of acquiring the real estate with little or no money down, you strike a deal to pay her 6% interest on $40,000 amortized over a 30 year term with a balloon due in 7 years. This is great. You find a young family and rent the house to them for $650 per month. The average for a 2 bedroom 1 bath in that neighborhood was $725 per month so your house was rented before the ink dried on your purchase contract. Now, you pay monthly expenses to:
- Nice old lady – $240
- Property management company (normally 10% of the rental value) – $24
- Rental Property Insurance – $75
- Property Taxes – $50
- Maintenance Fund – $50
- Total = $439
Now, you have Good Debt and have acquired an asset that generates a positive monthly cash flow of $211. Your payment on the home entertainment system will be $167. So you can use the income from your asset acquired with good debt to pay for your expense acquired through bad debt and still have $44 per month in excess. After 5 years, your home entertainment system is paid off and you enjoy a $211 positive monthly cash flow from that rental unit and you acquired an asset that someone else is paying for. This is an example of paying for your bad debt with good debt.
You may ask, “Can my home mortgage or car payment be good debt?” Sure. Almost anything can be good debt if you are willing to shift purpose. My meaning is, if you turn your home into a Bed and Breakfast where your total monthly income from the Bed and Breakfast exceeds the mortgage, insurance, taxes, and maintenance expenses of the home and the business, then at that point your home mortgage would become good debt. Hire yourself out on the weekends to be the private driver for someone and the income generated is in excess of the expenses for fuel, car payment, and maintenance, then at that point your car payment becomes good debt.
I am not recommending you never buy a home or a car. Or if you do you must turn your home into a bed and breakfast or your car into a taxi service. I am simply stating that there is bad debt and good debt. Most people are only aware of bad debt and they are taught that debt is bad on all levels. I’m sure you have heard, “Get out of debt and get a safe, secure job.” I am saying, “Get out of bad debt.” The safe, secure job discussion is a moot point on this site as Entrepreneurs are not seeking jobs but rather investments and opportunities. When you consider purchasing in the future, analyze whether you are about to incur good debt or bad debt. If you are about to incur bad debt, stop and ponder for a moment if there is a way to cover that bad debt with revenue generated from an asset acquired with good debt. If you find yourself in a situation and need some help determining how to cover a bad debt scenario with good debt, contact me and I am willing to brainstorm with you. If you want more detailed information on this subject matter, pick up Robert Kiyosaki’s book, “Guide To Becoming Rich” by clicking on the image.
Tags: asset, debt, expense, income, revenue
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