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Bad Debt vs. Good Debt

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!

  1. Comment by Nick Scalero
    August 9th at 9:14 am 

    One must be patient. Good debt takes time to show it’s value. It is not “get rich quick” but it is build over time. Think about where you want to be in 10 years… not where you want to be next month.

  2. Comment by Zach
    August 9th at 9:21 am 

    Question: You mentioned in a previous article why its not smart to want to pay down your personal home mortgage fast, bc you get tax deductions, etc. But your personal home is not producing cash flow, so techinically it would not be considered “good debt”. This would imply that it is bad debt which you would want to pay down fast and get rid of.


  3. Comment by Thach Nguyen
    August 9th at 3:53 pm 

    yes people get mixed up learning the differences between good debt and bad debt. My new american dream is to be debt free, but use leverage in the right way.

  4. Comment by Marco Santarelli
    August 10th at 11:27 pm 

    Zach: Yes, while it is true that your principal residence is not an investment, you could argue that your mortgage would be considered “bad” debt. For most people it’s a necessary evil because they need it to purchase the home in the first place (unless you buy “all cash”), and second the interest provides you a beneficial tax deduction.

    Bottom line is that the answer to this question is a personal matter and can change based on the person’s personal financial situation.

  5. Comment by Michael
    August 11th at 7:23 pm 

    There is an investor that leveraged their property which is now upside down. It cash flows over $200 monthly. The cash out was used to parlay buying other rental properties that also cash flow.

  6. Comment by David Cooper
    August 14th at 2:44 pm 

    The late nite TV seminars are returning with investing strategies that are true speculation wrapped up as real estate investing. New sheep to be led to slaughter

  7. Comment by Akinniyi Osho
    August 15th at 12:38 am 

    Dear Marco, thank you for sharing this article on good debt vs bad debt. the most important thing i have learnt is that debt is about leverage. Here is a further contribution to this article. Your house is a necessary expense and you need somewhere to live. Instead of paying off your mortgage why not invest in a positive cash flow income producing property and use the cash to pay more on your house payment. when you do this you’ll pay off your home mortgage faster. The other important point I must emphasize is that taking on debt is not bad in itself…its what you use the money you borrow to other words you must use leverage to your advantage. Thanks once more for this insightful article

  8. Comment by Clay
    August 15th at 6:45 am 

    Marco, great post! This is an issue that (myself included) takes some time to learn and understand. The word “debt” alone is inaccurate for the very reason you pointed out: there are 2 types of “debt”.

  9. Comment by Krohn Group
    September 7th at 12:01 pm 

    I totally agree with the article, and the opinion below, good debt is a LONG TERM investment… most people do not have the patience… and those people are flippers.. the funny thing is .. The guy who brought me into Real Estate always wholesaled and flipped houses. 12 years later.. he still needs money..

  10. Comment by REI
    September 13th at 7:15 am 

    So, basically we are talking debt vs. investment? Most people can’t distinguish between the two. Thanks for the insightful article Marco!

  11. Comment by Buck Mckenty
    April 2nd at 4:02 pm 

    Nice read. This blog is awesome.

  12. Comment by Mark L.
    May 24th at 4:46 pm 

    I am considering investing in real estate long term, will having multiple properties have a negative impact on my credit score?

  13. Comment by Tim Sweem
    May 29th at 5:40 pm 

    Hello Mark,

    I believe you are asking if additional “mortgages” in your name on your credit report will impact your FICO score and the answer is yes in the short term. Anytime you add additional debt it affects your credit score negatively. However, as long as you pay the mortgages as agreed, over time the score will come back up. Mortgages are considered better “debt” than say revolving debt, especially if the revolving debt starts to approach its maximum limits. If you are not financing the properties, it would have no affect at all on your credit score. I hope this answers your question.

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