How do YOU view debt???

24 Replies

Hello all you smart BP people!

I have a question for today:   How do YOU view debt?    

Here are some sub-questions that you can pick and choose from to add to the conversation:

--> What are your personal "rules" about using debt for your investments? Do you have limits?

--> How do you make debt work for you? 

--> What practices do you put in place that give you peace of mind? 

--> Have you ever been on the edge with debt or struggled with it? 

--> What have you learned from managing debt?   

--> Do you believe in --  own nothing, control everything?  Why or why not?   Is there any greater truth to -- own everything, control everything? 

--> Do you feel there is a difference between personal debt (credit cards, car loan, home mortgage) vs. investment debt vs. business debt? 

Thank you for the conversation!   

Some of you may know from another topic that I am an avid listener of the Dave Ramsey podcast.  Dave is a 100% cash person, and suggests that investors pay off all personal debt and then buy their first rental with all cash, a cheaper home, and that that's a good learning experience.  He also recommends that businesses build up with all cash, often taking a deposit on a sale if materials are needed in the startup phases.  I am personally contemplating how much debt I am comfortable working with and trying to find a balancing point that I can feel very confident with.  :)   

(P.S. I currently have a home mortgage (about 100k equity) and a margin trading account for options and stock shorting to enable certain types of trades that sits largely without use.  I am comfortable with both of these positions, although I am seriously considering paying down the home mortgage.) 

P.P.S.  I cracked open a Ken McElroy book last night to start brushing up. 

I am also a Dave Ramsey fan although I do not practice his no debt plan.  I use some debt, currently about 25% of assets.  If I am buying real estate I want a cap rate that is at least 3 percentage points above my cost of money.  I assume my return to be cap. rate + appreciation.

I don't use margin for buying stocks nor for consumer goods.  If I have to use debt for consumer goods I will go without.

By the way, I probably would not go above 50% debt.

Good Luck.

Bill

Debt is an incredibly valuable tool.  Like a chainsaw.  And like a chainsaw, it can be both dangerous, and very much not the right tool for all situations.

Ramsay would have us using only axes to clear a forest.  That will work, I suppose, but it will take forever.  And axes have their own dangers.

Debit is a tool, use carefully where appropriate.

Hi Karen,

This is a great topic and one that has been discussed before in a Kiyosaki vs Ramsey debate.

http://www.biggerpockets.com/forums/48/topics/9025...

I have taught the Ramsey course at church multiple times even thought I disagree with him on several issues.  He is an entertaining and excellent teacher.

For many years, I was a "debt free" advocate but I have modified my position and really like a 4 step criteria that Ron Blue uses for determining whether or not to go into debt.

Ron Blue's 4 step criteria are:

Does it make Economic Sense?

Are both spouses free from Anxiety?

Can it be undertaken with Spiritual Peace of mind?

What goals are being met that can only be met by going into debt?

I now utilize debt when I have a substantial spread between what I can conservatively earn on an investment vs what I can borrow the money from a lending institution.  The wisdom is in knowing when you have a conservative spread.

I will give you an example. I have owned SFR's since 2008. Until 2012, I paid cash and had a nice collection of properties. In 2012, I was presented a opportunity to buy an existing portfolio of 42 homes. That would double my inventory but I did not have enough cash to buy the entire package. I went to a local bank and got a portfolio loan at 4.875% on a 15yr amortization with a 5yr ARM feature.

When I went through the math, I was making 12-15% on my rentals that I had paid cash for.  My cash on cash return on the package of 42 was almost 25%.  When I factored in the principal pay down, my total return increased to almost 35% and that was just the first year of paying down the loan.

I have since purchased two more packages utilizing loans.  I also buy houses for cash as well.  So, I still utilize both strategies.

Good luck with your decision

In my opinion debt is an absolute must, and I'm not just saying that because I'm a lender. For my own investments I'm of the opinion is better. The more real estate debt I have then the more assets I control, the more return I get on my own cash and the more equity I'm using other peoples money to create.

Take a look at the most prominent real estate investors and developers and many are very highly leveraged and own hundreds of millions of dollars worth of real estate. I'd much rather be there then simply owning a portfolio of SFRs or small multi families without debt on them.

Leverage (debt) is what makes real estate so appealing. Combine that with the fact that if you purchase wisely and manage your portfolio prudently then you're generally not going to lose value on your assets in the long term.

If I can acquire a value creating asset by using someone else's money then I'm all for it. If I can acquire two of those by leveraging even higher then even better.

Of course there is a point where too much leverage can get you in trouble but most loans today require LTV in the 75% range and a debt coverage ratio of at least 1.25 and those two metrics alone can save you most of the time. Just need to make sure that you're actively managing so that your property stays desirable and profitable and also be sure to put aside enough to cover reserves and unexpected situations.

I should add that people sometimes get worried about "debt" in general. When used for investment purposes it's a highly useful tool that makes your work more efficient and easier. In my opinion it would be very unwise to avoid debt for real estate.

When used for depreciating assets or consumables then debt can be a waste and can get you in trouble if not managed properly. This is where most of the public has experience with debt and is the main reason why in general consumer debt has a negative connotation.

That's not to say that debt shouldn't be used for consumables, however. Let's say for example that my preference is to drive a $50,000 car and I have the option to pay cash or finance it. As long as the interest rate that I'm going to pay for the car loan is less than I can earn by investing that amount of cash, I'm going to be better off every single time by financing the car and allocating the cash elsewhere.

Debt isn't bad, just be strategic with it.

@Karen M.  

Hi Karen, this is a really good question. I think there is a mayor difference between good debt and bad debt. Good debt makes you money, bad debt costs you money. As @Bill Jacobsen  already mentioned, consumer debt is bad debt, as you do not gain anything from that. Mortgages are good debt, as the debt (usually) creates value for you.

As for what % to take on in debt, that depents on your personal risk tolerance. Personally, especially in the current interest rate environment, I would go for a higher rate of debt. Inflation will help you out in the long run and reduce the future value of this debt. Furthermore, a higher debt level gives you more flexibility in terms of acquisition.

Have a good one!

** draw a picture of the devil -- that's how I view debt **

Isn't Ramsey the same guy that says to pay the smallest debt rather than the one with the highest interest rate? I recommend embracing math as a good thing and ignoring anything to the contrary.

Paying for the first property with cash is good, in that it allows you to refinance to get your money back, however.

Originally posted by @Richard C. :

Debt is an incredibly valuable tool.  Like a chainsaw.  And like a chainsaw, it can be both dangerous, and very much not the right tool for all situations.

Ramsay would have us using only axes to clear a forest.  That will work, I suppose, but it will take forever.  And axes have their own dangers.

Debit is a tool, use carefully where appropriate.

I totally agree in fact I said something similar back in June.  

Cal C.

Real Estate Investor from Norcross, Georgia

Update Jun 03, 07:38 AM

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Leverage is like a power saw when used correctly it is great tool, but when not used correctly...

To add to @Chris Masons point, it is very important what you do with the money you pull out of a cash refi. If you go blow it on a shopping spree you are asking for trouble. If you find a relatively safe (what was in 2008-9?) investment for the money and have access to it then it makes sense. If you use it to buy more properties it can work, but only with a carefully thought out plan, always keeping in mind what happens if rents drop, vacancies soar, and house prices crater, like what happened in Atlanta. Also don't forget a lot of people had their lines of credits reduced drastically or cancelled altogether.

You have to have contingency plans in place.

@Alex Silang This is not an easy concept to understand as evidenced by the large amount of people who simply ignored overleveraging prior to 2007 to their great regret.

Originally posted by @Wilson Churchill :

Isn't Ramsey the same guy that says to pay the smallest debt rather than the one with the highest interest rate? I recommend embracing math as a good thing and ignoring anything to the contrary.

Paying for the first property with cash is good, in that it allows you to refinance to get your money back, however.

 He does that for psychological reasons, he is a math geek and understands the math very well.  However he also understands the power of small victories and feels those victories outweighs the interest difference.  He must be doing something right since he has helped millions get out of debt.  

Originally posted by @Cal C. :
Originally posted by @Wilson Churchill:

Isn't Ramsey the same guy that says to pay the smallest debt rather than the one with the highest interest rate? I recommend embracing math as a good thing and ignoring anything to the contrary.

Paying for the first property with cash is good, in that it allows you to refinance to get your money back, however.

 He does that for psychological reasons, he is a math geek and understands the math very well.  However he also understands the power of small victories and feels those victories outweighs the interest difference.  He must be doing something right since he has helped millions get out of debt.  

 This isn't Dr. Phil, this is bigger pockets! I would hope that visitors to this site are more sophisticated and can appreciate saving and making as much money as possible. Speaking only for myself, I "feel" better when I am making a mathematically correct decision regarding my finances rather than by making token payments on debts.

Wait, I'll ask my tenants.  They're the ones paying off the big *** mortgage. 

Originally posted by @Wilson Churchill :
Speaking only for myself, I "feel" better when I am making a mathematically correct decision regarding my finances rather than by making token payments on debts.

Which is why you likely don't have debt issues...

People who DO have debt issues don't generally think this way, and for them, psychological wins can be more powerful than mathematical wins...

I love debt! I jut passed over 2 million of debt with my local lender. The debt allows me to complete up to ten flips at once and have 11 rental properties. That debt makes me a lot of money. Without debt I would have maybe three rentals and be able to compete two or three flips at once.  With debt I probably make $250,000 a year more than I would without it. 

Debt scares the hell out of me.  I was raised by a very conservative mother who drilled it into my thick head that credit cards are evil and should never be avoided, although having 1 in case of true emergencies is important. My mother is happy with her paid off home and paying everything in cash.  She lives a simple life, and that is good for her.

But because of her I never have carried a balance on a credit card, and the only debt that I have is student loan debt at 2.75% (not too bad).  This student loan debt was a necessity and I have done well from it, but it still bothers me to have balances that I owe future money with.

What I recently discovered and was missing in that knowledge was the POSITIVE side of debt, specifically debt that you can qualify for, that you don't pay back (someone else pays it for you), as in real estate.

It still scares the crap out of me though, and while I go back in forth in my mind all the time about debt, I just try to make sure I don't overextend myself, and I'm always thinking down the road. 

I think it's important for me to use that fear of debt to keep my mind razor sharp.

I have a pending purchase on my 2nd rental right now, and sometimes I get into very negative mindsets where I am wondering what the hell I'm doing, and then other times I get into the mindset that millions of people do this, and I will be fine because I've tried to think through it and be prepared for anything.  It's only money... ;)

DEBT Is good as long as I control it FOR MY ADVANTAGE and it doesn't control me.

Some people can't use debt in a productive way so it's best they do not have it at all.

It's the similar argument for people who claim less dependents on the taxes so they have more taken out each year for a bigger check for them later. ( a forced savings plan for those with little impulse control).

Conversely there are those who say pay as little tax as possible and do not give the government an interest free loan and make more money investing it before the taxes come due.

It's like paying off your house. You could pay it off and have for example 300k dead equity which is devaluing each year with inflation and becoming worth less and less OR you can take that 300k and even with paying a 4% home loan can get 20% elsewhere. You come out 16% ahead plus multiple other value streams to increase that money past the 20% annual return.   

Originally posted by @David Roberts :

Debt scares the hell out of me.  I was raised by a very conservative mother who drilled it into my thick head that credit cards are evil and should never be avoided, although having 1 in case of true emergencies is important. My mother is happy with her paid off home and paying everything in cash.  She lives a simple life, and that is good for her.

But because of her I never have carried a balance on a credit card, and the only debt that I have is student loan debt at 2.75% (not too bad).  This student loan debt was a necessity and I have done well from it, but it still bothers me to have balances that I owe future money with.

What I recently discovered and was missing in that knowledge was the POSITIVE side of debt, specifically debt that you can qualify for, that you don't pay back (someone else pays it for you), as in real estate.

It still scares the crap out of me though, and while I go back in forth in my mind all the time about debt, I just try to make sure I don't overextend myself, and I'm always thinking down the road. 

I think it's important for me to use that fear of debt to keep my mind razor sharp.

I have a pending purchase on my 2nd rental right now, and sometimes I get into very negative mindsets where I am wondering what the hell I'm doing, and then other times I get into the mindset that millions of people do this, and I will be fine because I've tried to think through it and be prepared for anything.  It's only money... ;)

 So long as your leveraged rental generates positive cash flow, you can use it to pay other debt down more quickly.. A fear of debt is healthy, imo. It should temper your mind to make sure that all of your investments produce cash flow.

I grew up the opposite of @David Roberts  . I saw my parents lose  4 houses to foreclosure. Constantly putting bad debit in front of Bad Debt. Living far outside their means. But the result was the same, I was scared to death of detbt. I worked full time through college to pay for it in cash, Didn't have a credit or debit card into my late 20's. 

But I eventually went through a enlightenment where it comes to debt. Good debt is used to make money, bad debit is a creation to keep people enslaved. If you want the freedom offered you must learn to use debt correctly. 

"debt" is way too broad,,'debt' would include the payments on a $20k sound system/tv and debt on a house that is actually putting money in your pocket.

Is a mortgage on a cash flowing property 'bad debt', not in my book,,is debt because you went out and blew a lot of money on 'toys'  bad debt, I would say yes.

Now, you can't say all credit card debt is bad, if you've ever purchased a house needing rehab with a hard money loan, you may charge things that you will be reimbursed for when you get the escrow money put up for repairs.  

I agree with someone earlier, you have to remember who your talking about, Dave Ramsey is really more geared for a 'regular' employed person with no cash flowing business,,,,not someone that is a professional real estate investor that knows how to make money with debt.

If I followed Ramsey's model I would own 1 house, all cash,,and cash flow about $800 a month,,,I own 5 properties with debt and cash flow about $2750 a month,,,which do you think is better (and have over 25% equity in each of them)

Great discussion!  Debt does represent risk, so it is healthy to keep a balance for sure and be very aware of it.  Remember 2008??  I listen to Dave often.  I am glad I financed my real estate purchases in the beginning with fixed rate, fixed-term mortgages. His way would leave me maybe buying my first rental now with cash instead of starting over a decade ago and having a nice net worth. Funny how net worth never comes up in his debt-free screams.  A lot of them are debt free (which is great) but renting an apt somewhere.  With that said, I do not have credit card debt or car payments or timeshares or any of that.   Use debt wisely to finance assets that provide income and increase in value.  Avoid negative am loans, variable rates, calls/balloons and land contracts/contracts for deeds always!

Although I'm best known as a liquidity guy in California's probate legal community, I'll comment as both a lender and from my early days as a cash-strapped real estate investor.

Here's the question that needs to be asked about any kind of debt: "What's it's job?"

When I began investing, I couldn't qualify for the high interest rate mortgages that were offered at the time. So, I used credit cards. I paid the lenders' high rates which caused me to paus and really consider how much money, in dollars, each investment needed to make.

This was a great experience in terror and inconvenience as I had many of the disputes with bureaucratic credit card companies that others have, dispite being what I believe was the ideal customer/borrower. Credit card debt, in those days, required about 3% per month of unpaid balance to service both 1.5% for interest and the same for a 60 month amortization of principal. Clearly, there had to be better way.

I bought a 2nd TD from a carry back seller as my first note investment. What pain in the butt that was. And yet, it was wonderful. I was now in the cat's seat and could leverage some control over an asset worth much more than my investment. During this time, the market tanked, the debtor defaulted on the 1st and filed BK, delay upon delay, poor legal service from my attorney, etc. the education was priceless.

And this experience got me into the mindset of a creditor and soon lead to my hard money lending career. 

One lesson for debtors: don't borrow unless you're sure you can pay on time, 

Another one is to make certain you have several workable exit plans (tactics) in the event your investment doesn't perform and you've got to bail quickly.

Also, don't fight trends. If the market is changing, don't pretend otherwise. I watched in astonishment as a close friend took a casual approach to selling land for development in both Riverside and Orange counties, in So Cal, in which he had acquired with short-term seller carry back financing. When asked his opinion of the market (this was 2006) he told me that he believed and reasoned that land was the last real estate to be affected by a market change! That didn't prove correct for him.

I haven't had much debt in many years. I pay off credit card balances each month. I have modest size mortgages on my homes. My rental have very low or zero balances. I de-leveraged Prior to the last (Great) Recession and this is probably why I weathered through it without much worry.

As a lender, even a niche guy, I've watched who survives and who doesn't. Leverage is ok when it makes you money and stressful when it's a burden. It's best to be clear what it's role is in your business, investing and personal life.

Debt is good if you manage the risk. The FED is essentially punishing savers and rewarding borrowers and you can't fight the FED. If you get long term low interest fixed debt, you will always pay it back with cheaper dollars due to inflation. Real Estate purchases are the easiest ways to get such debt. A positive cash flow rental is the simplest way to borrow cheap and pay back with inflated dollars. Its exactly what the US treasury dept is doing as well with T bills.

But there is risk. The trick is to limit your debt so that you can ride out downturns, vacancies, depressed markets etc. If you have sufficient reserves and income to pay the debt payments even if you have no renters, you are in a pretty good place. If you have spent your last dollar buying rentals on margin, you will eventually get screwed. 

Id never take debt to buy stocks or any other volatile asset that I have no control over. Real Estate is the only exception. I don't have any CC debt, car loans or any other consumer debt that is not earning me money. I would take very low interest consumer loans (0-1%) if I had equivalent cash earning more elsewhere as a simple financial leverage.

I like listening to Dave Ramsey (apart from his Evangelical tangents) but his advice is meant for the people who don't understand anything about money (which is probably the vast majority).  His advice on paying off consumer debt is great. His investment advice is nonsense. His assumptions of 12% average return on "good growth mutual funds" is pure hogwash. He doesn't differentiate between average and compound returns.  He recommends front loaded mutual funds. He eschews real estate debt. 

Great discussion.  I love debt.  But I agree with most posters, it must be kept in perspective.  In other words, debt should only be used when it can generate a better return.  Additionally, when using debt, one must have the reserves on hand to cover payments when times are bad.

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