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.

Introduction

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!

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KCLau
KCLau

Personal finance author and trainer

    27 replies to "Get Rich with Excessive Debt"

    • yazidane

      I love the idea you share on the scenario..useful tips for us to apply

    • Rose

      Hi, I am starting a business which requires about rm100k.How can I raise the capital? Should I refinance my existing house for my business?

      • KCLau

        Refinancing your house for startup capital is one of the best methods. Because the loan is long term, at a low rate compared to others.

    • su

      Hi KC, if I have cash on hand, hates debts and mortgage, and not a risk taker, zero knowledge on any kind of investment. is it a right move to buy a house with cash instead of installment?

      • KCLau

        Hi Su,

        There is no problem. You don’t want to face sleepless night due to mortgage, do you?

    • chyokh

      Easy to say in theory. Keep buying and buying. Get yourself in debt up to your ears. You will be rich beyond your imagination, they say. Follow the herd because there is more money to be made. Buy high and sell higher.

      Remember the sub prime crisis and the 1997 Asian financial crisis ?

    • Chyi Thong

      Hi KC,

      For scenario 2, what happen if he cannot rent out his second house to get a 3k rental income? Then, he need to pay for 2 mortgage loans, means he need to dig into his savings to pay the loans.

      This is the case that made quite a number of retail investors became bankrupt during economic downturns when they failed to rent out their properties.

    • Belinda

      Hi KC,
      I’m planning to buy my first home but puzzling about how much down payment should I make in order to save more.

      For eg, should I just pay 10% down payment even I can afford to make 20% ? Should I get repayment in 30 years even I can settle it in 20 years?

      I had been advised to use bank loan fully to purchase a house rather than using own $, I wonder if this concept just fit on property investment. What do you think?

      Thanks.

      • KCLau

        Hi Belinda,

        There are two different, totally opposite groups:
        1. hate debt and want to be debt-free ASAP
        2. embrace debt because it gives them leverage to make more with less.

        Depending on which group you are in, or just right at the middle, you will have different approach to the situation.
        What I can say is if you are confident to make higher return than the interest rate charged on your loan amount, then you should go for the 2nd approach.

        • Belinda

          Thanks for replying my comment. Did you mean to use bank loan fully, if you are confident to make higher return than the interest rate?

          • KCLau

            Yes, when you can make better use of the money.

    • brandon

      Hi KC,
      can i make hire purchases a good debt? If possible, how?

      • KCLau

        if not mistaken, some companies bought their machine with hire-purchase.

    • Byron

      hi KC,
      in order to be more convincing in the scenario 2 you quoted, more realistic assumptions should be used. it would ended up worse than original state but will be realistic.
      example, you can’t assume “no down” deal (in contrast to scenario 1) and the rental is too good to be true (3k/mth for a 500k house? anyone would have bought the house rather than rent it. this kind of illogical case only can happen in renting singapore HDB where the singapore gov policy “slaughter” foriegners)

      • KCLau

        HI Byron,

        Thanks for your insight. I have simplified the matters just for illustration purposes.
        The easy part is to think like the rich. But to act like the rich, it is another story. For example, buying a property worth 500k and renting out 3k/month is not an easy task.
        If you can do it, you are on your way to become rich. In fact, there are people who can do that. Look at some real examples from Real Estate Investment Blog.

    • Byron

      hi KC,
      it order to be more convincing in the scenario 2 you quoted, more realistic assumptions should be used. it would ended up worse than original state but will be realistic.
      example, you can’t assume “no down” deal (in contrast to scenario 1) and the rental is too good to be true (3k/mth for a 500k house? anyone would have bought the house rather than rent it. this kind of illogical case only can happen in renting singapore HDB where the singapore gov policy “slaughter” foriegners)

    • marxy

      FAtduck & Peter,

      Split your (maximum attainable) capital resources, then buy two houses(with maximum spread in the purchase price) at one go. Maximize the good-debt (mortgage of the investment unit) and minimize the bad-debt (mortage of own-stay unit). Make your good-debt pay for your bad-debt.

    • peter

      interesting point here.. however isn’t it unavoidable if i need to buy a house when i get marry (first home)?

      • KCLau

        it is unavoidable if you want your own home.
        We only have three kind of relationship with money – earn it, spend it, or save it (invest).

        Buying our home is more towards “spend it” category.
        That depends on your own priority.

    • […] Get Rich using Excessive Debt […]

    • KCLau

      Hi Fatduck,

      If you are referring to Scenario 1 – buying a bigger house, that’s exactly the way how poor people get poorer.

      Scenario 2 is the way to get rich. The rich spend money to acquire assets. The poor spend more money for own consumption.

    • FAtduck

      If you cant afford to pay for the mortgage of your current home, how do u expect to pay the mortgage of a bigger house.. What if what i earned is just enough to pay the mortgage and support my family, then your plan of buying a bigger house wont work. the bank definitely wont loan u money as u wont be able to pay the mortgage of a bigger house.

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