Should I Use Debt?
I love money. Not in the greedy way, although I do have ambitious financial goals. I'm talking about the science of money.
It's a great combination of psychology (individual and group) and mathematics. Two of my favorite topics.
Good read from the IMF about it here for junkies: https://www.imf.org/external/pubs/ft/fandd/2012/09/basics.ht...
Many people, until they take the time to consider it, think of money as mostly a mathematical thing. But if it were just coldly about numbers, debt wouldn't be such a controversial topic.
In real estate, the terms "debt" and "leverage" are often used interchangeably. Yet, there are many who treat any kind of debt like the plague.
What are your feelings about it? What rules do you have about it? Are you someone who will avoid debt at all costs, buying a home only after you've saved enough to purchase it with cash? Or are you comfortable taking on debt for the right reasons?
Most people are comfortable with the idea of getting a mortgage for your primary residence, but what about for a rental property? A small business loan? School? Car?
What rules do you have about it? I'd love to read people's thoughts on this.
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#5 Multi-Family and Apartment Investing Contributor
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#5 Multi-Family and Apartment Investing Contributor
- Cincinnati, OH
@Brady Mullen, as you allude to and Bjorn hits on. Debt is just another tool, but a power tool. It makes things easier, if it is going well, but also more likely to cut your finger off (using table saw versus hand saw analogy here) if you are not careful.
If it is purely used to consume more, then it is bad. If it is applied appropriately, it still carries risks, but can supercharge your ability hit broader financial goals. My wife and I bounce back and forth on debt is fine and debt should be minimized. That being said, we are still in growth mode in our lives. So we have a mortgage on our primary and our one remaining rental. We have car loans, not because we couldn't afford to pay cash when we bought them, or pay them off now, but because we are borrow at under 2% and under 4% on each car.
School loans, both my wife and I had, but worked very very hard to pay those off early in our careers. They were cheap debt, but at the same point, not having debt gives your freedom. We were not traveling while my friends were. We did not buy new cars with our first paychecks that my friends did.
Overall, you are on a real estate forum. And one that most people here are still looking to grow their portfolios. Debt is a great tool for that. Clearly, most users of these forums are looking for personal financial freedom, not to build a major company. But like Finance 201 in college taught and like most companies, public or private, growth requires capital. Debt, mortgages or corporate bonds tend to be the lowest cost of capital available.
Yeah money is wonderful, perhaps the best tool ever. In my earlier days we always used debt. Debt allows you a bigger base of operation and a way to make more money. Unless you inherited wealth, debt enables you to generate income and appreciation provided you are willing to take risk and have the know how.
Today all debt is paid off and my wife and I are enjoying retirement with the cash flow from our rentals. I still look at properties every day but we are not buying anymore-I don't think. My wife is the main PM and we are blessed with great tenants.
Owning rental property and recreational land has been a blessing for us. Success is having enough money so you never have to think about it unless you want to of course.
In real estate, debt is a multiplier of effectiveness. You only have to use a fraction of your buying power to purchase the asset. But just like driving a car faster, it can increase one’s risk if they aren’t managing that acceleration effectively.
I think you have to know what type of ‘driver’ you are. If you can’t trust your lead foot you need to listen to Dave Ramsey where (more or less) “All debt is bad debt”. I fall more to the Kyosaki side and say debt that makes you money is perfectly fine.
But even with that, you have to understand the rules of the road getting into investment real estate. That your vehicle needs maintenance along the way to keep performing well… that your taxes will increase about a year after you buy your new investment vehicle, etc. Just like with a sports car, there is a learning curve to driving fast. if you know the road and how to manage your vehicle, debt just let’s you play the game with a faster car - and it is a blast! In 3 years we went from 0 to over 30 properties using leverage at every turn (2018-2020).
For the moment though, the Fed’s throwing out potholes with their rate increases, that have effectively reduced the benefit of leverage for investors to the point where it isn’t even worth pulling out of the garage these days it seems!
Randy
#5 Multi-Family and Apartment Investing Contributor
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#5 Multi-Family and Apartment Investing Contributor
- Cincinnati, OH
@Brady Mullen, as you allude to and Bjorn hits on. Debt is just another tool, but a power tool. It makes things easier, if it is going well, but also more likely to cut your finger off (using table saw versus hand saw analogy here) if you are not careful.
If it is purely used to consume more, then it is bad. If it is applied appropriately, it still carries risks, but can supercharge your ability hit broader financial goals. My wife and I bounce back and forth on debt is fine and debt should be minimized. That being said, we are still in growth mode in our lives. So we have a mortgage on our primary and our one remaining rental. We have car loans, not because we couldn't afford to pay cash when we bought them, or pay them off now, but because we are borrow at under 2% and under 4% on each car.
School loans, both my wife and I had, but worked very very hard to pay those off early in our careers. They were cheap debt, but at the same point, not having debt gives your freedom. We were not traveling while my friends were. We did not buy new cars with our first paychecks that my friends did.
Overall, you are on a real estate forum. And one that most people here are still looking to grow their portfolios. Debt is a great tool for that. Clearly, most users of these forums are looking for personal financial freedom, not to build a major company. But like Finance 201 in college taught and like most companies, public or private, growth requires capital. Debt, mortgages or corporate bonds tend to be the lowest cost of capital available.
All depends on what you use it for. With that said, the power of leverage is strong when used correctly.
Love the power tool analogy! Thanks, Evan!