Debt has always been considered as a liability. Yes, in most cases, debt is a liability because it is money owed to someone else. One classic example of a liability is a credit card debt. When you use a credit card, you’re taking a loan from the bank or company that issued the card.
With that loan come interest payments. You generally do not pay interest for the first credit card cycle (usually a month), but any amount not completely paid off after that first cycle is subject to interest. If you carry a balance on your credit card, then all future charges are also subject to interest; there is no more first-cycle grace period.
Furthermore, many credit card companies charge an annual fee for use of the card. Credit cards easily seduce the unwary into debt. Because no money exchanges hands, it may seem as if something is being purchased for nothing.
HOWEVER, debt isn’t always a negative thing. It is not always a liability as we are accustomed to. There is bad debt and there is good debt.
Bad debt is money borrowed to purchase doodads such as clothes, cars, or electronic equipment. You cannot expect to get a financial return from something purchased with bad debt.
Good debt is debt that allows you to purchase assets. An example is money borrowed to purchase rental real estate. The tenant’s payments are used to pay off the loan and generate cash flow.
It can be financially smart to carry good debt; it is never financially smart to carry bad debt.
Rich Dad Tip:
“Every time you owe someone a bad debt, you become an employee of their money. If you take out a thirty-year loan, you’ve become a thirty-year employee.”
In finance, there is what we call as “debt leveraging” where you leverage debt to your advantage to convert a bad debt into a good debt. One example of this is your credit card. Instead of using cash, you use your credit card to purchase stuffs. You use it for its convenience and for security purposes. However, you must PAY IT ON TIME to avoid interest and late payment charges.
Credit card companies have reward points. So by using your credit card, you can accumulate reward points and exchange those points into freebies. Then sell that freebie item. The result – cash! Or you can also accumulate points in exchange of reward points for a free vacation. Instead of using cash to purchase things that you need, you take advantage of your credit card to convert it from a liability into an asset.
Another example of debt leveraging is by using other people’s money. If you have an excellent business idea and you see to it to be profitable, then you should not use your own money to establish that business. Get a loan from the bank or borrow money from your friends and relatives and use it to fund your business while you invest a huge portion of your own money into other investments. When your business succeeds, you pay off your loan and you get the interest income from your own money plus you get the cashflow from your business. You can use the interest income of your own money to pay-off the interest of the loan you have. Isn’t it good to use other people’s money?
Last example is the self-liquidating real estate. You take out a bank loan to purchase a good location real estate. Make it as your investment and rent it out to tenants. You just pay for the downpayment to the bank and the rental income from the tenants would pay off your monthly mortgage to the bank. So you just paid the downpayment and once you fully paid your mortgage to the bank, then the rental property would be yours and it would start generating positive cashflow for you.
So everytime you will have a debt, try your best to make it from bad debt into a good debt.