Good debt VS Bad debt

One of the most important pieces of advice that I could give any potential investor is for them to understand the difference between good debt, and bad debt. In our society, we are raised on the assumption that all debt is “bad”, but that’s not always the case.

Let me show you an example, to highlight the difference:

Say you had $100,000 to invest in 2007. With these funds, you decide to purchase a $500,000 property in Sydney, using the $100,000 as your 20% deposit. You then take out a loan to borrow the remaining $400,000. Ten years later, that same property would now be worth $1,000,000. If you were to sell the house and pay off the debt ,you have managed to turn $100,000 into $600,000 in 10 years.

Taking it one step further, if you had purchased two properties, each worth $500,000 (splitting your $100k into two 10% deposits) and borrowed the rest ($900k), those properties would now be worth $2,000,000.

If you were to sell them and pay off the mortgages, you would have just turned $100,000 into $1,100,000.

This is the power of leverage.

What about other options?

  • If you had bought $100,000 worth of Australian shares, they would now be worth $90,000 plus any dividends you might have received.
  • If you had bought a $100,000 car that might now be worth $10,000.

It is true that you can also borrow to enter the stock market, but this is an option for only sophisticated investors as there are many hidden surprises for the unwary. I would warn against this option.

You can also borrow to buy a car – this is an outstanding example of bad debt. All cars depreciate in value over time whilst your loan will still sit there, accumulating interest. You will never make money on a car.

If you have $100,000 to invest in 2017, even though the Sydney property market may have just peaked again – what would you do?

Investing in property and using debt wisely is still a powerful way to provide for your future.

It’s not about “timing the market”   –   it’s about “time in the market”

 

Posted in: Property investment

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