Good Debt vs. Bad Debt - September 2024

By Sam Ayliffe, Director,  Astute Manly

Sydney’s Eastern Suburbs appeal to a wide cross section of buyers. While it’s true we have diverse property options, those wanting a quality home still need a sizeable chunk of funds at their disposal. The Eastern Suburbs market could be the most resilient market in Australia with a strong history of capital growth.

I always say, “ The best debt you can have is no debt but if you have to carry debt carry investment debt!” 

I'd rather have tax deductible loans, even if you’re rate is slightly higher than Owner Occupied. Why? Because buying an investment property requires as 'Investment Loan',  achieving a tax deduction.

Of course, if you had no debt at all, I would be out of business, however, I am sure you would then leverage and invest in property and create Investment loan (tax deductible).

Plus you continue to refer us to your family and friends anyway.

What is the difference between good debt and bad debt?

 People don’t really understand the difference between good debt and bad debt.

It’s actually rather simple when you narrow it down.

Good debt is debt that you can claim as a tax deduction, debt that relates to an investment, a tool of trade in your business or something that enables you to have that tax deduction, yet good debt is often only really good if the interest rate is competitive and comparable. You wouldn’t want to take good debt and an extremely high interest rate just for the tax deduction. 

Bad debt is simple. Bad debt is debt you cannot claim and it’s debt you really want to try and focus on getting rid of as soon as you can. An example of bad debt would be credit card debt. You really should try to avoid not paying your credit card in full as it’s extremely high interest and this is bad, so always pay off the ‘statement balance’ in full. However, the most common bad debt is your family home loan, your owner occupied reliance home loan that you took to buy the place. This is not really bad debt as it’s better to have a mortgage paying off to ZERO than having a rental payment that never ends, however your focus should be on how can I pay this off as fast as I can.  Income is the natural way, but there are others, like investing, or adding improvements and selling your ‘home capital gains tax free and buying a cheaper home to lower debt’. Sometimes this is called ‘flipping’ but it is hard to do so be measured and use experienced networks around you.

How can you keep borrowing to buy property assets to get multiple properties in your portfolio?

There are really two main things that hold people back:

1. Deposit or equity, and

2. Borrowing power

There is a third one you can control. It is commonly just you. ‘You' may hold back yourself from making some potential good investment decisions.

The hardest property you’ll ever buy is your first one, home or Investment!

But once you buy that you start paying it down (usually you’re home but it could be an investment property, where you are a Rent-Vester… rent where you want to live, but invest where you want to make money. Buying your first property will open equity as it grows, hopefully buying well, and you could then leverage into other investments without needing to save that hefty deposit or ask for a government grant to be able to help you with the property purchase. Be wary of builder / developer buyer bonus’s, they are often in the price and often relate to a new property, not established.

Equity you then create, ie Value of home, vs Home Loan balance owing, is where you can leverage and achieve tax deductions by taking on good debt in investment properties and expand your overall wealth.

Taking on an investment property of course has its risk, you need to be calculated.

An important aspect of any debt, whether home or investment property for you, is cash flow. Plus structures, names on Title, Trusts, etc, but that generally is for the more advanced investors, but not dismissible in conversations.

Cash flow is critical to your monthly budget and you need to make sure that it works for you.

Cash flow can be assisted if a property has eligible tax depreciation deductions too, which typically can be up to 40 years on building costs, so you will be surprised! This also lowers tax!

Once you know this is okay and you have done some modelling with your broker, the next ingredient for an investment property is capital growth opportunities  and tax deductions.

This is how you can expand your portfolio by leveraging with good properties that grow accessing equity and have strong rental returns to ensure cash flow is okay.

Discuss the concept of opportunity cost and delayed gratification - investing for the future

The opportunity cost is the cost that you may have to sacrifice to cover a shortfall in buying and leveraging that investment property to enable you to grow your overall wealth portfolio. 

This may mean you:

(a) have to pay taxes, agents fees, legals, etc, and 

(b) might be putting in $1000 a month to own and run that investment for example, but it may save you $5000 a year in tax, for example

However, the delayed gratification far outweighs this seemingly small cash flow pain if it works for your budget, because this enables you to sell that subsequent investment in years down the track and the windfall would be able to be used to repay its loan and use profits to repay your home loan and assist in reducing your bad debt. 

Of course, normally with any investment there is a capital gains tax implication which some people are fearful of. 

I have no concern with paying a capital gains tax because it means exactly that: you’ve paid tax on making money so you just have to share a little to make a lot. A ‘Capital’ ‘Gain!’ 

If you made $300K and held the Investment for say 5 years, and had to give the tax office say 35c in the dollar (less 50% holding 12 months +), then giving ATO $52,500 and banking $247,500 isn’t bad, especially if it saved you taxes along the way and the cash flow gap was not too challenging.    Tip it into your home loan, owner occupied mortgage, and your investment just helped you pay off your home sooner! 

What are the most common mistakes that investors make?

Some common mistakes investors make are simply not getting involved in an investment property when their cash flow and their budget enables them to do so due to fear of the unknown. 

And then not choosing ’specialists’ to guide them, for fear of costs or privacy. Don’t worry about that, a cost should deliver a better return, and privacy is paramount in Australian businesses!!! 

That’s why it’s important to surround yourself with talented people and I always believe that you need to have :

1. a financial Broker (like me, not owned by a bank, with over 50 lenders, experienced in all aspects of lending, with an experienced team to guide you) 

2. a financial Adviser especially for cashflow, and SMSF Superfund investing (we have an experienced team here too)

3.  property investment agent to meet your brief, and make you money in your property choices.

4  a solicitor to handle the settlements, legal rego, etc, and finally 

5. Your accountant, for searching and helping you save tax and find investment deductions

A few common investment mistakes I’ve seen overtime is potentially…

Buying next door because they love where they live. 

Even though you love the area, this area may not have the growth drivers to achieve the potential growth that a smarter investment may have in an area that delivers drivers such as population, growth, employment opportunities, great schooling, great transport, hubs and linkage, great services etc. etc. 

Leads me to the above ; please use the professionals around you to guide you. Think about your job, would you ask an unskilled untrained person to do that as good as you could?

Another mistake is some people like to put money (deposit) into their investment property where I feel you be better to fully finance it but only if you still owe money on your home.

What is the best approach/ philosophy to adopt to financing your way to real wealth?

Don’t be shy to invest, but make sure that you’ve done all the numbers and can afford it.

Surround yourself with quality people that live and breathe their daily job.

You do your job well, so trust them that do their job well to help you get you into better home loans and great investment opportunities.

And ask questions… If you’re unsure, you don’t have to do it, but don’t regret missing a good investment opportunity just because it’s a suburb or area you’ve never lived. 

I can give you two examples of what I heard someone say many years ago…

(a) I will buy when the market dips!    Don't wait… waiting 5 years, could have had 7% per year for 4 years, then -5% the year it dips! You are still 23% HIGHER than when you should have bought!

(b) I would like to pay off my home first!… well, a typical home loan term in Australia is up to 30 years. Even if you pay it off in 15 years, half the term, imagine what potential growth and tax deductions you have missed in all that time! 

How does working with a mortgage broker help you achieve your goals?

This is where I come in and what I absolutely love doing at Astute Financial Manly.

We are a private, family owned, Australian business. 

We not only challenge a bank for our clients to better your interest rates, we look at most of the lenders for a better deal. 

We also look at options where you may have equity and be able to leverage into an investment property if you choose to. But we make sure we get structures right, and try to do what we would do, if we were you!   No big bank pays us to sell them regardless of your best-interest! They can only offer them, we offer a lot of them!

It doesn’t bother me where they buy or what they invest in. 

We just hope they make a smart decision and we will certainly help with structuring it appropriately so they can maximise their investment debt and minimise their home debt.

Having been in the industry for 25 years and not owned by any particular bank and being a private practice and being able to do what we would do if we were in our CLIENT’s shoes.

I’ve seen many clients buy a modest investment, in an area they did not know, nor would have thought of, for $330,000 and achieve double that in less than 10 years as profit to them.

My favourite thing today is looking after the kids of my clients, and seeing them get on the property ladder too, building their future too. This will be me helping guide my children into their financial future too, down the track.

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