Jul 13, 2017
Good Debt Vs Bad Debt
Sayings like ‘Only buy what you can pay for in cash’ and ‘Pay off your home before you invest’ obviously weren’t made up by successful property investors!
These days it’s virtually impossible to become wealthy simply by investing the surplus from your wages or salary.
High income taxes and living costs leave precious little money in the pay-packet, and deposit accounts barely break even after low interest rates and inflation are taken into account.
To achieve financial independence you need to ‘leverage’ your surplus money. In other words, use it to borrow more money to invest in assets that rise in value and put you ahead of the game.
There are three types of debt:
1. BAD DEBT
This is money borrowed to buy non-essentials that decrease in value, such as fancy cars, recreational vehicles, clothes and electronic gadgets.
Worse, the interest rates for a personal loan or credit card is usually much higher than a loan to buy a home or investment property. And the repayments come straight out of your pocket because the interest isn’t tax-deductible.
If you spend your surplus money on ‘lifestyle’ items without putting a solid financial strategy in place, then you’re liable to be living on the pension after you retire.
2. NECESSARY DEBT
The most common example of this type of debt is a home loan. The interest payments aren’t tax-deductible, but the property isn’t included in government assets tests and the debt provides a roof over your head.
If your home has made a solid capital gain after you’ve repaid the loan, then this debt can still turn out to be be a good investment.
3. GOOD DEBT
This type of debt enables you to buy assets that are likely to increase in value, such as investment properties.
The interest on the loan is tax-deductible because it’s a business expense, and the rental income helps to repay the debt.
You can also claim depreciation and use negative gearing (ie. the costs of buying the property are bigger than the rent income) to make the tax department contribute to the repayments.
A tax depreciation report is necessary to assist in gaining a tax refund from a positively geared investment property. For more information, see Drive your portfolio with depreciation!
Even if your investment property is positively geared, chances are that your tax refund and the rent will cover the loan repayments.
The right approach is to spend less money than you earn, and invest the difference wisely now. Then you’ll enjoy greater financial security later.
With careful planning and the right investment strategy, you can acquire properties that are likely to increase in value over time.
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