In recent years the word âdebtâ has developed something of a bad name, but the truth is that not all debt is bad â in fact, some types of debt can do you a power of good.
Going further than that, âgood debtâ is one of the best ways to start leveraging the power of your money and creating passive income streams that help you develop real wealth. Without debt, very few people would own a house or be able to use their high earnings to start building their âempire.â
Here we take a look at the steps you can take so that your debt serves you well rather than endangering your financial future.
The Differences between Good Debt and Bad Debt
Itâs important to understand what we mean by âgoodâ debt and âbadâ debt.
Good Debtis the type that allows you to accumulate assets that will increase in value; the loan interest is often tax deductible, and you can use the income derived from the asset to repay the debt.
Examples include:
Property
Shares
Investing in managed funds
Bad Debtis the type that buys goods, services or assets that have no potential to generate any income and/or depreciate in value. The loan interest is non-tax deductible, and there is no income from the asset to pay back the debt.
Credit card debt â if not repaid within the interest-free period
Personal loans to buy cars
Most family home loans
Using the Power of Good Debt
You can take several steps to get your personal finances in a position to start using good debt to create wealth. Here are seven of the best:
1.Debt Consolidation
Servicing multiple debts is costing you way more than you need to pay in interest and fees. It can often benefit you, for example, to increase your mortgage and use the extra funds to pay off other, inefficient bad debt like credit card balances and personal loans. Your home loan repayments may stay the same, but you will use its lower interest rate to pay off higher interest debt.
2.Making YourSavings Work Harder
Many people like to keep money in a cash savings bank account as âemergencyâ funds or a âbufferâ, making them feel more secure. The fact is that this money could be more wisely kept in an âoffsetâ account linked to your mortgage. You will earn a higher after-tax return and reduce the term of your home loan, all without locking up the funds.
Managing cash flow is key to minimising bad debt. The main idea is to reduce interest payments â this can be done by increasing the frequency of payment on a mortgage, increasing the amount paid, paying your entire salary into an offset account or using an interest-free period on a credit card to pay for daily expenses (freeing up other funds for paying off your home loan) without paying any interest.
4.Borrowing To Create Wealth
Once youâve minimised the bad debt, itâs time to start creating some good debt. This is called âgearing.â Providing you invest wisely and your assets increase in value, gearing helps you create wealth, as the income (and capital growth) from the investment pays off the debt and exceeds the costs of servicing that debt. Property or shares are often a good strategy here. You can create the extra funds by borrowing against the equity in your home, taking out a margin loan, or investing in a managed share fund.
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5.Using Lump Sums Wisely
Occasionally you may receive a large lump sum of money from bonuses, inheritance etc. Try to use this to pay off bad debt or perhaps consider making extra contributions into superannuation.
6.Debt Recycling
Debt recycling is where, as you pay off your home loan, you redraw the equity you have built up to invest in shares or other property; again, the bad debt becomes a good debt that can earn you an income and can be used to pay back the loan, as well as providing tax breaks. Any excess income can also be fed back into your home loan to pay that off quickly and make further interest savings.
7.Invest In A Geared Managed Share Fund
A managed share fund is âinternally gearedâ so that you donât have to take out an investment loan yourself, yet you can still benefit from the âgearingâ effect of borrowing to invest. Here the fund manager borrows (at wholesale rates) on behalf of investors to invest in international or local share markets.
With all of the above steps, itâs important to get quality advice and to understand the risks and the potential returns.
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This is called âgearing.â Providing you invest wisely and your assets increase in value, gearing helps you create wealth, as the income (and capital growth) from the investment pays off the debt and exceeds the costs of servicing that debt. Property or shares are often a good strategy here.
Wealthy individuals create passive income through arbitrage by finding assets that generate income (such as businesses, real estate, or bonds) and then borrowing money against those assets to get leverage to purchase even more assets.
You can enhance your financial position and create long-term wealth by leveraging debt to invest in appreciating assets such as real estate, consolidate high-interest debts to improve cash flow, use high-yield savings accounts or borrow to acquire profitable businesses.
His approach involves using debt strategically to enhance wealth. Kiyosaki categorizes debt into good debt and bad debt, with good debt being that which helps build wealth, such as loans used for acquiring income-generating assets like real estate, businesses or investmentsââ.
Billionaires (usually) don't sell valuable stock. So how do they afford the daily expenses of life, whether it's a new pleasure boat or a social media company? They borrow against their stock. This revolving door of credit allows them to buy what they want without incurring a capital gains tax.
Debt can make you rich when you use other people's money to control assets that appreciate in value and create cash flow that grows your net worth. Good debt creates leverage, for a small monthly fee you can control an asset worth many times the monthly payment.
Borrowing to invest (e.g., in property or shares), or gearing, can be a powerful means to build wealth over time as it enables you to purchase more investments than would be otherwise possible.
You can earn money doing just about anything these days, from watching video games to drinking beer to renting your garage to renting yourself. Even traditional extra-income sources like babysitting, tutoring and selling garage-sale stuff have been transformed into excuse-proof tasks.
Ninety-three percent of millionaires said they got their wealth because they worked hard, not because they had big salaries. Only 31% averaged $100,000 a year over the course of their career, and one-third never made six figures in any single working year of their career.
For example, very rich people might borrow money to acquire a company if they think they can improve its profitability. They might also borrow to fund a startup business, or use margin in their brokerage account to invest in more assets that will help them build wealth.
Musk has to contend with over $13 billion of debt still weighing down a swiftly sinking Twitter, Tesla's profits shrinking because of a lack of demand and new products, and a world that is generally sick of his schtick. In Muskland, everything is connected by money â problems at one business bleed into the others.
Money is first and foremost created when someone gets a loan. The bulk of money represents banks' debts to the public. When a bank grants a loan, both its assets and liabilities increase. The lending bank asks the customer to sign a promissory note and adds the resulting receivable to its assets.
Every time banks loan funds to consumers and businesses they create new money. That loaned money, in turn, gets deposited back into the banking system where it gets loaned again, creating more new money.
The bottom line. Personal loans can be a valuable tool for building wealth if used wisely. You might consolidate high-interest debt, invest in profitable ventures or finance home improvements. However, it is important to determine your debt tolerance and make responsible borrowing decisions.
Debt can be considered âgoodâ if it has the potential to increase your net worth or significantly enhance your life. A student loan may be considered good debt if it helps you on your career track. Bad debt is money borrowed to purchase rapidly depreciating assets or assets for consumption.
Debt is often cheaper than equity, and interest payments are tax-deductible. So, as the level of debt increases, returns to equity owners also increase â enhancing the company's value. If risk weren't a factor, then the more debt a business has, the greater its value would be.
Introduction: My name is Kareem Mueller DO, I am a vivacious, super, thoughtful, excited, handsome, beautiful, combative person who loves writing and wants to share my knowledge and understanding with you.
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