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Not all debt is bad. Find out how debt can help property investors build a solid portfolio here.

A lot of people have hang-ups around debt. After all, most Australians are raised with the concept of debt as something that’s bad. We were told that we should not have any debts… or at least we should work to get rid of them all ASAP. 

But in a way, this is wrong—especially in the context of purchasing assets like property investments. 

Debt, if managed correctly, can fit neatly into your portfolio strategy. And in most cases, you don’t always need to really focus on reducing debt for such purposes. 

If you’re not convinced, let’s talk about debt a little bit more in this article.

Debt is a Tool

If you’re familiar with the work of American businessman and author Robert Kiyosaki, you’re probably aware of the concept of ‘other people’s money’. 

In his classic wealth-building book “Rich Dad, Poor Dad”, Kiyosaki explains that by leveraging other people’s money, you’re getting an ROI from someone else’s resources. And so, this comes into debt play. Incurring debt, even if it’s from banks, is an example of other people’s money. 

But on the other hand, the contradiction is that most people go out and say, “I want to reduce my debt. I don’t want to live my entire life just paying down my debt!”

Of course, this is a valid concern. Regardless of our position towards debt, we don’t want to be keeping debt for our whole life. At the end of the day, we all want to have no debts, no loans, nothing.

So, where do we draw the line? 

It’s simple really – there is a time and place for everything. 

There is a time for paying down debts and making sure that we are living without such financial obligations. But there is also a good time to incur debt. 

And one of those times is when you’re building a property portfolio. 

After all, you can’t really pay the full amount for property investment, right? If you want to build a property portfolio, you can’t possibly pick and choose a lot of properties and buy them completely off your wallet (unless you’re already a billionaire).

Let’s face it. The reality is you need to use the tools available at your disposal to be able to build a solid property portfolio. These tools include loans and debt. 

In other words, debt is a tool that property investors use to propel their strategies forward. 

Instead of thinking about reducing loans, property investors must simply be aware of their debt and not ignore it completely. When you’re starting out, this is usually not something you should focus on.

Interest Only vs Principal and Interest Repayments

If you’re already convinced that incurring debt is something you need to do if you want to start building a great property portfolio, there is one more thing you have to think about. 

And that’s none other than your repayment option. 

You see, there are two payment options you can take advantage of when taking out a loan. You can either opt for an interest-only repayment scheme or the interest repayment scheme.

With the principal and interest loan scenario, the concept of that is that you’re going to be paying down your debt over time. Let’s assume you’ve got a 4% interest rate on your mortgage at the moment. 

Paying down your debt is going to give you a capital return of 4% a year, right? Because you’re going to be reducing your debt, the cost of debt is 4%. So, for every $100 you’re putting into paying down the debt, you end up making a gain of $4.

In contrast, if you’re on an interest-only basis, the cash-on-cash returns can cover that expense. Plus, the interest component of your debt on an investment property is tax deductible against your marginal tax rate.  So, you get the added benefit there.

Now, I talked to one of my friends the other day who had all his property investments at an interest-only rate. And I asked him this: 

“Would you keep your loans on interest only forever?”

My friend said no. He said that he would switch his investment properties to principal and interest only when his investment properties have paid off his principal place of residence. 

So, his property investments are all on interest. Only, the cash flow from those property investments goes into paying down his bad debt as fast as possible. And then, once that’s paid off and he’s got no more bad debt, well, then all of the other cash is surplus. And at that point, it might make sense to start paying down the debt.

Now, there are two ways to think about that. You could either say, “Sure, it might make sense to pay down the debt.” But you could also think that it makes more sense to actually just go and get more investment properties to pay for that residence.

Make Your Choice

Debt is a very powerful tool that can be leveraged by property investors to build wealth. It can help us find the right footing and build a portfolio that can replace our income from our jobs. Not to mention allow us to start earning profits from investments. 

In short, debt is like a rocket ship that can help us reach the stars.

But just like any rocket ship, debt is a dangerous tool. Debt is dangerous when used improperly and unwisely. 

That’s why proper strategy and commitment to the strategy are necessary when getting into debt. 

You must always be aware of how debt is affecting your portfolio and cash flow. What’s more, find the balance and know the risks you are willing to take to get to where you want to be. Know that not all debt is bad. But all debt can be bad if you do not know how to handle it. 

So, don’t be afraid of debt. Just simply be prepared to use it wisely.

Keen to explore your own property strategy?