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August 8th, 2011 by Marco Santarelli
This is an investing concept that’s not often thought about within the context of real estate, but it’s vital for you to understand the differences between these two types of debt.
Bad debt is typically referred to as consumer debt. What makes bad debt “bad” is the fact that it’s not being used on anything that produces cash flow or appreciates over time. Vacations, clothing, iPads, and anything else that doesn’t work for you in generating a return on that debt is considered bad debt.
Bad debt sources usually come from credit cards, but they can also include car loans, store credit, and personal lines of credit. Interest rates are usually high and are generally higher than most good debt sources.
If that isn’t bad enough, the interest you pay is almost never tax deductible. The only exception to this rule might be a qualifying business expense if you can deduct such an expense.
Good debt is also known as mortgage debt. What makes good debt “good” is the fact that you’re using the debt to purchase income-producing property. And that income-producing property is an asset which generates a return above and beyond the expenses and cost of the borrowed money. This is how you borrow money to make money.
In addition, the interest you pay on that mortgage debt is tax deductible. It’s treated favorably by the IRS and is a great reason to choose real estate as an investment.
With mortgage debt, what you owe today is what you’ll be worth tomorrow. Think of it this way: as your loan is paid down by your tenant month after month and year after year, that paid-down loan principal has now become equity and, therefore, adds to your net worth. This happens instantly, and almost magically, with every payment that’s made!
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