Tuesday, October 16, 2012

How to Get Rich - Kill Your Bad Debt

Do you know the difference between good debt and bad debt ?

Do you know how to make debt work for you ?

The wealthy know the answers to these important debt issues, you should too !

Bad Debt 

Bad debt is defined as any debt that you incur to purchase something that you do not receive an income from. Most consumer debt falls into this category.

Credit cards, car loans, lines of credit, even most mortgages fall into the bad debt category.

Good Debt 

Good debt, yes you probably guessed, is any debt that you incur to purchase an income producing asset.
Investment loans, brokerage loans, mortgages for investment properties, etc. fall into this category.

Kill Your Bad Debt

When it comes to building wealth, the key is to eliminate  (or kill) all of your bad debt. You cannot possibly get rich if you have to continually carry around the ball and chain of bad debt. Your income will continue to make someone else rich, namely your bank or other financial institution. Not a good plan.

To kill bad debt, you can either pay it off with a repayment plan or find a way to convert your bad debt into good debt.

Repayment Plan

For most, unless you already have liquid investments, this will be their only option for killing bad debt. Start by identifying which of your debts incurs the highest interest rate. If you have credit card debt, this is normally where you start. Next, proceed to the next highest rate and so on.

To free up funds to put towards repayment, you will likely have to make sacrifices to your lifestyle or increase your current income level. Either way, it will not come without some pain. Motivation is the key in any debt repayment plan. It will take time and commitment.

Turn Bad Debt to Good Debt

If you already have investments that are liquid (easy to turn into cash) and will not incur a lot of income tax if you were to cash them in, it may be best to look at this option for killing your bad debt.

First, cash in all of your investments that fall into the above category. Second, use this cash to pay off all of your bad debt. Third, obtain a new loan for investment purposes. Fourth, use the borrowed funds to buy back your previously cashed in investments.

This will in effect turn your bad debt into good debt. The big advantage of this option is that in many countries, you will now be able to "write off" your interest payments as an investment expense on your income tax. This can be a significant amount, especially as your income increases.

The key for this option to work is that your investment income or expected gains must be greater than the interest you will be paying on the loan. Check with your local adviser before trying this option.

R. I. P.  

Both of the above options could be used together to ensure your bad debt is killed and hopefully will never resurface from it's ugly grave. Motivation and determination to improve your financial life will be absolutely necessary to achieve this ultimate goal.

As always, I welcome your comments and suggestions for future topics.


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