There is a difference between good debt and bad debt. All most people know is bad debt. They don’t know that debt can be good.
My definition of bad debt is a little different from how banks define it.
A bad debt is a debt that you have to pay back from somewhere else
Let’s say you take a loan to buy a car. The value of the car drops from the moment you drive it out of the dealer’s shop. You spend money on maintenance, fuel, and accessories. The car doesn’t bring money into your account. The car only takes money out. And you have to pay back the car loan from the money you got from your job or business.
Why is it bad? If you suddenly lose your job or your business goes south, you won’t be able to pay back the loan anymore. Then, the debt becomes really bad. You cannot sell the car and make gains because the value of the car would have dropped.
Some might argue that the car would increase productivity which would eventually lead to more money. That can be true. But not for everyone. The status of the debt doesn’t change. It is still a debt that cannot pay itself. The thought that it would pay itself is assumed.
Good debt is different. What makes debt good is not what it is used for, instead, it is its capacity to be paid back with gains by what it is used for.
A good debt is a debt that pays for itself and leaves you with gains
It is not about what you buy. Let’s take the example of the car loan again. But this time, you made a deal with a driver to use the car under one of these ride-hailing platforms (like Uber). And your monthly return can pay for the monthly payments of the loan and leave some extra money in your hands. That is a good debt.
The car loan example can be a crude one but it is just to let you know that anything can be turned into an income-producing property. This method is most common with real estate.
Smart real estate investors take a loan to buy property, revamp the property and put it up for lease, and (if everything goes well) the rent from the property pays for the monthly loan payments with some leftovers for the investor to enjoy.
Now imagine if the monthly payment is $250K and the returns (minus maintenance) is $3M, that is some $2.75M to play with. Why shouldn’t the investor do it again? That is some very good debt.
By the way, it takes skill and knowledge to be able to make a real estate investment profitable like this.