Personal Finance

Used Wisely, Debt Can Absolutely Produce Wealth: Here’s How

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As someone who has struggled for about half of his life with debt, what it really was, and how to handle it, I guess it’s best to start out by trying to define it. I believe this is where some of the challenges in reference to debt stem from.

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Merriam Webster’s Definition of Debt:

  1. An amount of money that you owe to a person, bank, company, etc.
  2. The state of allowing money to someone or something.

In other words, debt is defined as something borrowed or owed.

This type of definition then leads to sayings like, “Avoid debt like the plague” and “All debt is bad, dangerous, or scary.” Oftentimes, we’re taught that having everything paid off, or being totally debt-free, is true financial security.

Related: Another Way to Use Real Estate Debt Wisely

Maybe it’s actually fear that causes us to feel this way — fear of losing what we worked so hard to accumulate. Or, maybe it’s the fear of not being able to pay our debts.

This supposed feeling of security if an asset is paid off doesn’t necessarily mean that the asset is any more productive nor that it is any more secure (especially if insurance is being properly utilized).

Are We Really Afraid of Debt Because We’re Afraid of Expenses?

In a recent article, I covered the attributes of a Scarcity Mindset vs. an Abundance Mindset (“How to Uncover Amazing Deals by Simply Changing Your Mindset”). I believe that the drive to get completely out of debt is closely related to the Scarcity Mindset, as focusing solely on reducing expenses can be quite limiting.

Focusing more on production may be less limiting and, therefore, is more closely related to the Abundance Mindset.

Varied Definitions of Debt

Many people have to distinguish for themselves between their wants and their needs. Teachers like Dave Ramsey, author of The Total Money Makeover, profess brilliant strategies to help folks who’ve lost their way to get their financial lives back on track. One such strategy is to first have an emergency fund set aside, and then to develop a plan to whittle away at the smallest debt, and then to proceed to attack the next largest debt, and so on and so forth.

Other gurus, like Robert Kiyosaki, author of The Cash Flow Quadrant, discuss the differences between Good Debt and Bad Debt. Robert wrote that his Rich Dad would often say, “Every time you owe someone money, you become an employee of their money. If you take a 30 year loan, you become a 30 year employee, and they may not give you a gold watch when the debt is retired.” Rich dad did borrow money, but he did his best to not become the person who paid for his loans.

Good Debt was debt that someone else paid for you, and Bad Debt was that which you paid for with your own sweat and blood. This is why he encouraged rental properties — because the bank gives you the loan, but the tenant ends up paying for it.

For me, it’s not that I believe the normal definition of debt is all wrong, but I prefer the accounting definition of debt, which is:

Debt = Liabilities > Assets

Debt is not just any form of borrowing; it’s simply having liabilities greater than your assets (things that could be converted to cash). The opposite of debt is Equity, having assets greater than your liabilities.

For example:

assetsandliabilities

As you may see from the example above, to me, true debt is when your assets are less than your liabilities.

I’m also a believer that the true path to wealth is to increase cash flow and that our focus should be more on creating more assets than liabilities. After all, aren’t your tenants paying off your rentals? So, why not fully utilize your mortgage interest deductions and property depreciation?

Replacing Debt with Productive Liabilities

My favorite approach to defining debt was covered by Garrett Gunderson in Killing Sacred Cows.

He pointed out that liabilities are just a part of life and that we really need to understand the differences between the three types of debt:

  1. Productive Debt
  2. Consumptive Debt
  3. Destructive Debt

Obviously, Productive Debt is essentially borrowing to make yourself or your balance sheet more valuable (for example: real estate, business loans, student loans, etc.).

Consumptive Debt would be like taking out a second mortgage to buy furniture or buy a car to look cool, as opposed to taking out an auto loan for a work truck, which would be considered a more productive type of debt, as it would bring in more revenue for your business.

Destructive Debt is a little different, as the purchase is neither productive nor consumptive; it’s actually destructive (for example, drugs, gambling, pornography, etc.).

I tend to agree with his approach, where you can increase liabilities to increase your wealth and prosperity. This is exactly what I’ve done. I could have stopped at the 10 or 20 properties and tried to pay them down to become debt free, but I’m less inclined to do so, especially if my tenants are paying down my loans for me, and I’m keeping all tax benefits.

Related: Debt Service Coverage Ratio (DSC) – What it is and Why it Matters For You!

I believe in a more productive approach (towards abundance) by leveraging up intelligently and safely and increasing my overall wealth. My wife and I are cash flowing quite nicely, and we utilize insurance vehicles that can easily pay off all our real estate holdings, if that’s something one of us decided to do upon the demise of the other.

Why would I possibly care if our rentals were ever paid off if my wife and children were totally protected with adequate insurance coverage?

So, Let’s Look at Some of Garrett’s Advice

  • Never have destructive liabilities.
  • Choose consumption wisely. Never incur consumptive liabilities that exceed your assets and therefore put you into debt.
  • Never borrow to consume.
  • Focus on increasing productive liabilities, or the liabilities that come with greater corresponding assets.

This advice is pretty straight forward, but it doesn’t hurt to consider how productive you are with your debt. Although I believe that the true path to wealth is cash flow and that paying off debt can become less important (especially when utilizing proper insurances), I also understand that there are limits to this strategy. Taking on too much debt could bring unnecessary stress or a larger work load, so it may be equally as important to understand your own personal preferences.

So, how productive are you with your debt? Are you afraid of debt or do you embrace it as a way to build your assets?

Leave your thoughts, arguments and opinions in the comments below!

Since 2007, Dave Van Horn has served as president and CEO of PPR The Note Co., a holding company that manages several funds that buy, sell, and hold residential mortgages nationwide. Dave’s expertise is derived from over 30 years of residential and commercial real estate experience as a licensed Realtor, a real estate investor, and a fundraiser. As the latter, Dave has raised over $100 million in both notes and commercial real estate. In addition to his investments and role as CEO, Dave’s biggest passion is to teach others how to share, build, and preserve wealth. He authored Real Estate Note Investing, an introduction to the note investing business, helping investors enter the “other side” of the real estate business.

    Michael S. Investor, Property Manager from Louisville, Kentucky
    Replied about 5 years ago
    very interesting article. I would be the person that is concerned but not scared of debt. The reason I am is that because I don’t play good offense (high income earner) so I am in a sense forced to play good defense which I play 2000-01 Baltimore ravens defense. So that would be my main reason for keeping my debt and expenses low. I still want to get good debt that renters will pay off, don’t get me wrong. I just feel like building my real estate investing business on solid foundation will set me up for success for years to come. After all the current home I live in was an investors who lost his shirt in 2008 but who seen that coming? except for peter Schiff lol. Thanks for the great article!
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 5 years ago
    Hi Michael, thank you for the positive feedback and for sharing your story! I understand where you’re coming from, because I felt that way too. Most of the income from cash flow and the equity build-up in my investment portfolio all came from me utilizing loans though (notice I didn’t say debt). Best, Dave
    Etienne
    Replied about 2 years ago
    Nice. This will be my first good debt move.
    Todd Garrigus Involved In Real Estate from Beaumont, CA
    Replied about 5 years ago
    Great article! I’m just getting started and I really like the approach and mindset to debt. Its kind of how I’ve always felt about it, but never heard it voiced. Thank you, Dave Van Horn.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 5 years ago
    Thanks for reading Todd!
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 5 years ago
    Thanks for reading Todd!
    kris
    Replied about 5 years ago
    Get NNN property with non-recourse loan, so zero worries. cash flow is low 4-5% COC, but good as estate planning tool
    Kyle Hipp Investor from Appleton, Wisconsin
    Replied about 5 years ago
    Kris, that is a very low return which could be increased in a simple index fund. What is your plan once the lease is up and the company decides that the old building no longer meets their needs and they move on? Seems like a lot of backend uncertainty for what you would want to be a hands off investment…
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 5 years ago
    Kyle, I agree. Tenants can move out, non-recourse loans can be expensive (especially with rate and opportunity cost), and there can be better estate planning tools as well.
    kris
    Replied almost 5 years ago
    In retirement, they say pull 4% /yr, so a million in 25 yrs is gone. With NNN, you have land value, plus building last more than 2 ys, so no loan in 26th yr, if lease renewed, return zooms to 30%!!! In my area I have seen drug store for 40 yrs, and still going!!!
    Aroldo Villarreal Specialist from San Antonio, TX
    Replied about 5 years ago
    Great article! At the beginning of 2014 I bought Dave Ramsey’s Financial Peace book, not because I was in debt, but I wanted to understand his principles. Right after that, I read Rich Dad Poor Dad, and I was totally confused. It was a coincidence that I read them back to back and it threw me into a big roller coaster of deciding what was the correct thing to do. I figured out that there’s no right thing. I got great things from both books and have a great investor mentality with great budgeting habits.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 5 years ago
    Hi Aroldo, thanks for your comment! I agree, many books have good ideas, we just have to harvest what’s best for ourselves. Dave
    Elizabeth Blazina Investor from Seattle, Washington
    Replied about 5 years ago
    Dave, very good advice! I am curious though, what type of insurance protection are you referring to with regards to your rental properties being covered in case of emergency.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 5 years ago
    Hi Elizabeth, Thank you for your question! I use many types of insurance from home warranties, home owner insurance, and title insurance, to disability and life insurance, but primarily I’m referring to life insurance, where I sweep money into the policy and can access it shortly thereafter. Also, I plan to cover this topic with a little more detail in a future article. Best, Dave
    Jeff Brown from San Diego, CA
    Replied about 5 years ago
    I’ve found debt to be very much like most things in life. If used wisely it becomes a tool for success. Digging ditches with a pick ‘n shovel works well. Not so much when digging with a wrench.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 5 years ago
    Jeff, agreed. It’s usually not the tool that’s the problem; it’s either how it is being used or who’s using it.
    Sukey
    Replied about 5 years ago
    Thanks for making me think Dave. You asked “Are you afraid of debt or do you embrace it…” I WANT to be brave and confident and embrace debt. I wouldn’t say I’m afraid, more that I am bothered. Unfortunately that bother is quite literal. Large debts keep me up at night even when I know that (a) I can pay them off, and (b) I am financially secure and can weather almost any storm. It is indeed a mindset and for me it is taking a lot of work to change that mindset. The less rational side of me takes over when I am at my weakest, when my mind can wander more freely, in those brief moments between sleeping and waking.
    Sukey
    Replied about 5 years ago
    Thanks for making me think Dave. You asked “Are you afraid of debt or do you embrace it…” I WANT to be brave and confident and embrace debt. I wouldn’t say I’m afraid, more that I am bothered. Unfortunately that bother is quite literal. Large debts keep me up at night even when I know that (a) I can pay them off, and (b) I am financially secure and can weather almost any storm. It is indeed a mindset and for me it is taking a lot of work to change that mindset. The less rational side of me takes over when I am at my weakest, when my mind can wander more freely, in those brief moments between sleeping and waking.
    Frankie Woods Investor from Albuquerque, NM
    Replied about 5 years ago
    I enjoyed the article and definitely agree with the three types of debt. I think using good debt in moderation is a huge benefit, but you must always maintain a level of security (e.g., emergency fund, debt-to-income, etc.).
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 5 years ago
    Hi Frankie, Good point. I believe the best form of security is massive positive cash flow. You can’t eat equity, so it’s good to treat your real estate like a business. Best, Dave
    Roger
    Replied about 5 years ago
    No discussion about debt is complete without taking a look at how it affects risk. Debt shifts the risk for the entire cost of the property onto your comparatively small down payment. When property values go up, you look like a genius. When property values go down, it wipes you out (as millions found out during the financial crisis). Also, there is “safe” debt (i.e. fixed rate mortgages) and risky debt (i.e. adjustable rate mortgages). ARMs are wonderful when rates are falling, but they can wipe out your cash flow when rates go up. Ignore the lessons of the early 1980s at your own peril.
    James
    Replied almost 5 years ago
    Nice article. What types of insurances are you referring to?
    James
    Replied almost 5 years ago
    Nice article. What types of insurances are you referring to?
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 5 years ago
    Hi James, I use many types of insurance from home warranties, home owner insurance, and title insurance, to disability and life insurance, but primarily I’m referring to life insurance, where I sweep money into the policy and can access it shortly thereafter. I plan to cover this topic with a little more detail in a future article. Best, Dave
    kris
    Replied almost 5 years ago
    As said estate planning. Land is worth something and building will last more than 25 yrs. So, if lease is renewed, your return in 26th yr on NNN, is 30% since no loan. Thanks
    kris
    Replied almost 5 years ago
    As said estate planning. Land is worth something and building will last more than 25 yrs. So, if lease is renewed, your return in 26th yr on NNN, is 30% since no loan. Thanks Reply Report comment
    Raj
    Replied almost 5 years ago
    Great article sir. I was also afraid of debt first but then as I read more into the topic and educated myself better on debt I was less afraid. I still try to stay in comfortable range for the debt and use debt arbitrage to help build wealth little by little. For one of the commentors above regarding debt biting back i was afraid of that so try to purchase investment properties that you would be able to make payment even if its lost a renter and you have to cover some payments and also at a great value where you can always sell prop and not lose to foreclosures. This is great article very important info when understood can help you get over some fears. raj
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 5 years ago
    Hi Raj, Thanks for your comment! I agree with you that it’s not wise to use debt in a way that causes you to be over leveraged. Best, Dave
    Shaun Reilly Landlord and Rehabber from Newton, Massachusetts
    Replied almost 5 years ago
    Using leverage in anything can be done well and done foolishly. In your personal life people will say do all cash, credit cards are evil, only buy things you can pay for with the cash in your pocket… Yeah probably not a great idea to run up the card and pay 20% interest on your groceries week in and week out. But if you have the money and you pay them off every month you get: – a 1 month interest free loan – an easy record of all your purchases for the month – a much quicker easier experience for pretty much every transaction – never have to worry about not having enough cash (that you do have some place) on your person – pretty much every card has some kind of reward program you earn just by using it If you use this wisely it is much better than cash, and this is assuming you don’t have anything special with the cards or work the system at all for the rewards. Using financing on property makes sense since you can get into them faster and easier. Make sure you cash flow and take the tax deductions. I do like the thought of having places free and clear to increase cash flow and to reduce risk since you do have that payment obligation if you are vacant or not. I view the tax benefits for real estate financing as a nice bonus. It isn’t a goal since you actually spend that dollar on interest in order to deduct it. It isn’t like depreciation where you get to pay less taxes without spending any real money to get the deduction. Typically if you don’t over leverage and have good reserves you should be able to weather a storm with your portfolio. You can have those big events though so there is always some extra risk with leverage. You didn’t hear stories after the crash of people losing their free and clear portfolio when there non-existent loans adjusted from a teaser rate but the property values dropped 30%. Like most things every situation is somewhat unique and your personal level of usage of debt/financing/leverage in any aspect of your life needs to be evaluated do determine what is the best course of action for YOU and YOUR given situation.
    Jose
    Replied almost 5 years ago
    Dave, thanks for the concepts here. I am currently struggling in changing my mind to be more aggressive with loans. Right now I only have a 75% loan to cost, which is a 50% loan to value of only 50% of my properties. So I only have 25% of my total portfolio under a lean. I started 2 weeks ago a new loan on other properties… It feels great to have that cash flow cleaner without the loan payments, but after a while it just seemed ridiculous to have that extra without any tax deductions from interests, and since the money that comes from the loans dont produce taxes, then I will just continue to buy more rental units, and multiply the effect. It is really hard to change that mindset, but I have found that the most that you can break your “confort zone” the better. Our only and biggest limit is TIME. So in order to bring the income/time graph to grow exponentially…. I have learned that good loans are the best and quickest way to go…. way beter than flipping… Again, thanks for the article !!
    Patrick
    Replied almost 5 years ago
    Nice article! I like the thought process with regard to debt. My approach to debt also incorporates the ever important interest rate. For instance, I have a .9% loan for a vehicle that I won’t pay off early unless it’s needed to get a better debt to income ratio. Another example is one of my properties I refinanced at the perfect time and got a 3.37% 30 year rate. After accounting for inflation, the interest paid is trivial. Like you said, it also helps that the tenants are paying that mortgage of course!
    Patrick
    Replied almost 5 years ago
    Nice article! I like the thought process with regard to debt. My approach to debt also incorporates the ever important interest rate. For instance, I have a .9% loan for a vehicle that I won’t pay off early unless it’s needed to get a better debt to income ratio. Another example is one of my properties I refinanced at the perfect time and got a 3.37% 30 year rate. After accounting for inflation, the interest paid is trivial. Like you said, it also helps that the tenants are paying that mortgage of course!
    Patrick
    Replied almost 5 years ago
    Nice article! I like the thought process with regard to debt. My approach to debt also incorporates the ever important interest rate. For instance, I have a .9% loan for a vehicle that I won’t pay off early unless it’s needed to get a better debt to income ratio. Another example is one of my properties I refinanced at the perfect time and got a 3.37% 30 year rate. After accounting for inflation, the interest paid is trivial. Like you said, it also helps that the tenants are paying that mortgage of course!
    Clinton Warner Investor from Arima, Trimidad
    Replied almost 5 years ago
    Great article ! Knowing the difference between a good debt and a bad debt is the key. When you acquire the knowledge you remove the fear of acquiring debt.
    George
    Replied almost 5 years ago
    The line between good debt and bad debt is fickle. A student loan for med school is good debt. The return on investment is long but proven to be good. A loan to pay undergrad tuition at a private school for a social work degree is not a good ROI and I believe to be bad debt. Going into debt for consumer goods is always destructive.
    Joakim Esaiasson Wholesaler from Traverse city, Michigan
    Replied almost 5 years ago
    Great post, i make total sense to me, but like people are saying its hard to change the mindset of it.
    Rick Grubbs Rental Property Investor from Salisbury, NC
    Replied almost 5 years ago
    A lot of wrong thinking on debt comes from being out of balance in one direction or the other. As a minister, I know that every truth from Scripture or otherwise, has a balancing truth. Truth taken out of context without its balancing truth leads to error. The Bible has many cautions about the misuse of debt and the dangers of it. But there are also Scriptures which exhort us to make the most of what we have been given and multiply the resources God has entrusted to us. We are to be “wise as serpents but harmless as doves.” Thanks for giving one of the most balanced articles on debt I have seen in a while!
    Brett Snodgrass Investor from Indianapolis, IN
    Replied over 2 years ago
    Fantastic post! Enjoying the read.
    Christopher Blair Investor from Saint Petersburg, Florida
    Replied about 2 years ago
    Enjoyed the article. Another great perspective on how debt can be beneficial is outlined in the book “The Value of Debt: How to Manage Both Sides of a Balance Sheet to Maximize Wealth” by Thomas J. Anderson. The basic premise is that you should manage your personal debt as a company utilizes their debt for tax deductions and decrease their weighted average cost of capital (lower your WACC and it increases your discounted cash flows and thus the value of your firm). He has some great tables in the book outlining examples of how not paying down debt will actually increase your net worth.
    Kaleb Carsten Investor from Mitchell, South Dakota
    Replied almost 2 years ago
    It’s a great article, I read Rich Dad Poor Dad before I got started in real estate and just recently read The Total Money Makeover. I have been trying to verbalize my thoughts between the two. Good to see someone else has the same mindset!