written by KCLau @ KCLau’s Money Tips
This article shows you how the rich get richer with excessive debt. Bad-debt-free makes you a freeman. But if you know how to leverage with good debt, that’s the exact secret of wealthy people.
Paying debt is like a nightmare to ordinary people. Most people hate when it comes to the due date for mortgage installment, car loan installment and credit card debt. Probably the reason debt gets so much hatred is because it is associated with bad consumer debt most of the time. Those are really bad debts that we should hate and avoid. In order to get rich, make friends with good debts instead.
How Good Debt Makes You Rich
For illustration purposes, I will show you two different scenarios how a person handles debt that affects his financial situation. John earns $10,000 each month, spend $5,000 and save the other $5,000. Figure 1 shows his current cash flow and net worth charts.
Figure 1: John’s monthly cash flow and net worth chart.
For easy illustration, let’s assume John’s only asset is his house worth $200,000. His outstanding mortgage is $150,000, leaving him a net worth of $50,000
Scenario 1: Buy a bigger house
John found a great deal to buy a bigger house which is worth $500,000. So he sold his existing house, and use the $50,000 remaining cash for down payment. After buying the bigger house, his mortgage installment increases. Moreover, all other home related bills also increase because a bigger house needs more electricity energy supply, more maintenance works, more quit rent etc. This resulted in higher expenses – $8,000 per month. His surplus dropped to $2,000 per month only. Figure 2 shows his new cash flow and net worth charts.
Figure 2: John’s monthly cash flow and net worth chart after buying a bigger house.
Scenario 2: Buy another house for investment purposes
Instead of moving into a bigger house, John decided to invest in real estate by buying another house for rental income and capital appreciation. The new house is worth $300,000 and he got a deal that doesn’t require any down payment. His monthly expenses rise and in fact it is just the same as moving into a bigger house shown in Scenario 1. However, because the new house is rented out for $3,000 a month, his income rises to $13,000. This allows him to continue to save $5,000 per month. Figure 3 shows
his new cash flow and net worth charts after the investment.
Figure 2: John’s monthly cash flow and net worth chart after investing in a new house for rental income.
Simply looking at the net worth chart, Scenario 1 and Scenario 2 are identical. But Scenario 2 will definitely makes John a wealthier person because he has increased his cash flow. After 1 year, his saving is double of the case of moving into a bigger house.
Bad-Debt-Free vs. Good-Debt-Free
Good debt works for you. Bad debt makes you its slave.
Good debt increases your income. Bad debt decreases your savings.
I know some people think that mortgage of the homes they are staying in are good debts. But in fact, it is a bad one because it doesn’t increase your income.
I want to be bad-debt-free. At the meantime, I want to learn how to leverage my investment with good debt.
Please note that if John’s houses appreciate by 10% a year, it is calculated from the total assets of $500,000. This means he gets $50,000 return a year. But if he didn’t buy the house, how much can he get for 10% return from other investment such as mutual fund? He can only invest with the monthly $5,000 surplus, which is just a small fraction of $500,000. If John prefers to be totally debt free, he reduces the chances to get rich faster.
If you want to be totally debt free, it might cost you a great fortune!