Can Debt Ever be a Good Thing?

Is there ever a time when debt can be a good thing?

We all hear that we should get rid of debt. Cut up all of your credit cards. Pay cash for everything. If you can't afford it, don't buy it.

Honestly, these are good statements--usually.

Once in a while, you hear about the exception that it's okay to borrow to buy a house. This might be a true statement, but the reasons people often use to support THIS suggestion is laughable, if it weren't for the fact that so many people believed it.


One reason is okay. That is depreciation. This term simply means that since the house is getting older, it will become less sturdy or less valuable. The value depreciates, and you can write off this amount from your income on your taxes, which means that this helps you pay less taxes, but this is true, even when you buy a home with cash.

So what is the MOST often used reason that people say that it's okay to borrow money to buy a house? Mortgage interest is deductible. That's right. If you pay $1,000/month for your mortgage with $50 of that going toward the principle, then $950/month goes toward paying interest (the bank's fee) to borrow money to pay for that house. (Yes, in the beginning, it's about THAT bad. It gets better the longer you stay there.) Since the mortgage INTEREST is deductible (not the payment toward the mortgage PRINCIPAL), you get to deduct roughly 15% to 45% of this amount from your taxable income, depending upon your income bracket.

That means that you get back anywhere from about $140 to $430 on your payment of $950 of interest. That's great! You get a deduction; it's like free money.

Wait a moment! What if I told you that you give me $10, and I'll give you $4? Would you consider that to be a very good deal? Maybe if you're ME, but that's what this "tax benefit" is for YOU. Don't get me wrong. Make sure that you claim it, but don't take out a loan thinking that you're getting "free money."

Remember our first question. Is there ever a time when debt can be a good thing?

I still haven't answered that.

Many investors will borrow money with the following idea in mind.

If you find a house that costs $100,000, and you have $100,000 cash, you can do one of two things. You can pay for the house in full, or you can put down 20% on it ($20,000) and borrow $80,000.

Why would you borrow if you had the cash? Consider the following examples:

Example #1: Buyer pays $100,000 for $100,000 home.

Example #2: Buyer makes $20,000 down payment on $100,000 home--owes $80,000.

For this exercise, let's pretend that property values increased by 4%. Let's revisit our examples.

Example #1: Home value is worth $104,000. Buyer made 4% on initial $100,000 investment.

Example #2: Home value is worth $104,000. Buyer sells home, repays $80,000 loan, and keeps $24,000. Buyer made 20% on his initial $20,000 investment.

This is called leveraging. Yes, both made $4,000 profit, but the second buyer could buy four (4) more homes (for a total of five) with that $100,000. This buyer would have made $20,000 ($4,000 would have been made on each of the five homes).

There is a downside to this. Notice that I had you assume that the values INCREASED by 4%. If the property values DECREASE, then that second guy would lose a lot more than that first guy buying with cash.

So recall our first question. Is there ever a time when debt can be a good thing?

So far, our answer is that it COULD be a good thing, but the market has to improve. So this approach is a gamble.

Now let's consider another scenario.

I know somebody who borrowed money, and he was charged 4.5% interest.

He used this money for an investment that pays 37.5%. Do you think this is a good deal?

I sure do!

THIS is a situation where it makes sense to borrow money and be in debt--when it MAKES MONEY FOR YOU.

Debt is NOT a good thing when you buy a TV that loses its value the minute it leaves the store. It's not a good thing for a personal car, which loses value as soon you drive off the sales lot. Credit card debt isn't very wise to buy the latest fashion in clothes. Don't think it's a good idea to use a credit card to buy things ON SALE, either.

Can debt ever be a good thing?

Yes, when it makes you money and you are in control of that investment (opposed to waiting for the market value to increase) and NO OTHER TIME.