WHAT is the difference between good and bad property debt?
Most people I meet think all debt is bad: It’s something you should avoid or clear as quickly as possible.
However, debt can be your friend. Good debt will work day and night for you and earn more than it costs to keep.
Australia’s most successful property investors have been “friending” it for years.
With residential property’s track history of roughly doubling in value every 10 years, if you borrow $400,000 to buy a $500,000 property today, it’s likely that a decade from now you will have a $1 million property earning commensurate rent.
You will also have achieved $600,000 in equity, even without paying down your initial loan.
You might decide to borrow against that equity and expand your portfolio, or sell your property and do something else with the profits.
Either way, for a relatively small deposit, you will have bought a valuable asset and achieved cash flow and a capital gain.
If you have equity in the home you live in, banks are also likely to smile on you when you decide to invest in some residential property.
And if you are a high income earner, you might negatively gear your investment for tax advantages if interest on the loan and other costs exceed your rental income.
That kind of success hinges on wise choices and sound financial advice.
Without them, bad debts are easily incurred.
Bad debt is money you might not be able to afford.
A popular example is the new car that loses value the moment you drive it away from the showroom.
If it’s for personal use, it will never earn you money and you could be carrying finance charges on something that will be worth around 20 per cent less than what you paid for it a year later.
Bad debt scenarios associated with residential property investments can usually be foreseen or protected against. Among them are paying too much for the property, taking on too much debt or accepting uncompetitive interest rates, seeing your property value erode in a weak market, or feeling the pinch of a prolonged rental vacancy.
You can insure against fires, floods or other disasters but it’s also important to factor in the possibility of changes in personal circumstances like the loss of your job.
With prudence and good advice you should prosper from a property investment, but don’t gamble.
Find a financial adviser with a good track record.
That fee could be the best money you ever spend.
>> Tony Winterbottom is a general manager of Defence Housing Australia.