There is no such thing as a good mistress, but there is one mistress you should avoid at all costs. This mistress is a financial mistress. She is ruthless and will leave you high and dry. This financial mistress is bad debt, and you will regret it if you get entangled with her.
Bad debt can be alluring and even fun at first, but the relationship will eventually sour. At first, you get to buy things and do things NOW without waiting to enjoy life. Though exciting initially, bad debt inevitably rears its ugly head when it’s time to collect.
The problem with bad debt is that it’s never used to buy anything useful or productive. Shopping sprees, toys, and fun trips can provide temporary pleasure, but all these things drain your pocketbook and resources away from more productive uses. In addition, many things you buy with bad debt, like cars and toys, require continual upkeep, which is a constant drain on your bank account. And all this is before we even talk about the cost of debt – interest.
Most consumer debt (credit cards, personal loans, etc.) is particularly bad debt – generally coming with interest rates over 20% – but it’s not just the high-interest rate that is the problem, but the fact that they take away from other resources that could be used to create income and add to net worth instead of taking away from it like a bad debt.
Just look at the high rates and debt burdens plaguing borrowers:
Interest Rates by Category:
- Credit Card: 24.1%
- Used Cars: 13.7%
- New Cars: 8.7%
- Mortgages: 7.1%
Total Debt by Category:
- Credit Card: $986 Billion
- Auto Loans: $1.6 Trillion
- Mortgages: $11.9 Trillion
The middle class is racked with bad debt, and it’s the single biggest reason preventing members of this class from progressing and moving up the ladder to the echelons of the wealthy and ultra-wealthy. And it’s not just individuals guilty of reveling in bad debt. Poorly managed companies can fall into the same traps when they go into debt for things that tear down instead of building up their company. Lavish company parties, non-productive travel, and other wasteful uses can drain a company’s resources and lead them into oblivion.
We’ve talked about the bad mistress of debt, but there’s a flip side. There’s good debt, and instead of being compared to a mistress, it’s more like a trusted business partner.
Good debt will finance your dreams if you have a good business plan or model. It wants you to succeed because if you succeed, that will keep good debt happy and in your good graces.
Engage with the right type of debt; you will see your net worth grow instead of watching it shrink like with bad debt. Individuals and companies who leverage good debt put money to productive use where it works for them instead of the other way around. Instead of taking money out of your pocket like bad debt, good debt puts money in it. Those who understand this achieve wealth – those who don’t stay in debt and the middle class.
Good debt gives back more than it takes.
Taking out a commercial loan charging interest of around 7% to acquire an apartment building that produces income well above the interest charged, then it’s debt well worth undertaking, especially when the funds required for the interest payments plus principal come from the investment itself. The tenants are essentially paying the loan cost, creating perpetual cash flow.
Debt doesn’t have to be a dirty word. If used correctly, debt can be a tool for creating exponential wealth – especially if used to create multiple income streams.
Why not use debt to acquire multiple properties instead of just one? What if you could create four streams of income instead of just one?
For example, assuming a down payment requirement of 25% by most lenders on commercial real estate, $1,000,000 can be used to acquire four $1,000,000 properties creating four streams of income instead of just one income stream if the debt were not used. An investor could double their income stream even when factoring in debt service expenses.
In the right hands and for the right reasons, debt can be a positive force for creating and maintaining wealth. Used for the wrong reasons, debt can be an unforgiving mistress that will take her pound of flesh for years. Using good debt to acquire productive assets vs. using bad debt to acquire depleting assets is the difference between the wealthy and everyone else.
Instead of looking at interest payments as a burden to pay the price of non-productive things, the wealthy consider interest a necessary expense for acquiring productive assets needed to generate cash flow to build and maintain wealth. One type of debt in the hands of the middle class is liability. The other type in the hands of the wealthy is a tool.
What kind of debt are you interested in? A liability or a tool? Your answer will determine the likelihood of you achieving your financial dreams.