When Debt Goes Bad

by | 11, Dec 2021

For today’s episode, we’re going to give you the pure nuts and bolts that you need to know. The difference between good versus bad debt.

If you’re buying a thing that sits there and loses value and produces no kind of cash flow on credit, Is it good or bad debt?

We will talk about these things…and more in another episode of Multifamily Investing Made Simple in under 10 minutes.

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Tweetable Quotes:

Good debt versus bad debt, I think the simplest way I can sum it up is consumer debt..” – Dan Kreuger

“To be a great investor you need to understand how to leverage the different types of debt advantageously.” – Anthony Vicino

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Anthony Vicino and Dan Krueger
Passive Investing Made Simple – Available NOW!

When Debt Goes Bad

Anthony Vicino : [00:00:15] Hello and welcome to multifamily investing made simple, the podcast that is all about taking the complexity out of real estate investing so that you yes, you person with the headphones on or listening in the car can take action today. I’m your host. Anthony Vecino of Invictus Capital, joined as always by Dan.

Dan Krueger: [00:00:35] Caught off guard didn’t know you starting.

Anthony Vicino : [00:00:37] Yeah, well, I knew I was starting and I still didn’t have anything prepared there for that

Dan Krueger: [00:00:41] Middle, didn’t even know what we’re doing.

Anthony Vicino : [00:00:43] I don’t either. So this is one of our beautiful ten-minute episodes where we’re going to dive into a topic and try and explain it, simplify it as quickly as possible. Just give you the pure nuts and bolts that you need to know. Today’s episode is going to be the difference between good versus bad debt. Oh my god, this is this one. Ok, guys, here’s our challenge to ourselves. We’re not going over ten minutes. We’re not going to get on a rant. We’re not going to do it.

Dan Krueger: [00:01:12] Well, we have nine minutes.

Anthony Vicino : [00:01:13] All right. So here we go, Dan. Difference between good and bad debt

Dan Krueger: [00:01:19] Go, hmm. Good debt versus bad debt, I think the simplest way I can sum it up is consumer debt. Edit, if you’re buying things

Anthony Vicino : [00:01:27] That wasn’t simple at all, I’m still

Dan Krueger: [00:01:28] Confused consumer debt, if you are buying a TV on a credit card, if you’re buying a couch on a credit card, if you’re buying a thing that sits there and loses value and produces no kind of cash flow on credit, I would call that bad debt. And this assumes there’s interest involved if it’s one of those interest-free things where you get an interest-free period of 12 months to buy the couch and you’re going to pay it off in 12 months. Great, do it. I’d vote for that all day long, but if you’re paying, you know, credit card rates to buy consumer products, I would throw that in the bad debt category. Good debt is debt that is being used to acquire assets that hold and or gain in value and ideally produce cash flow that more than covers the interest expense.

Anthony Vicino : [00:02:16] Yeah. So to recap this. You’re saying that commercial debt is bad and debt that we use? What did I say? I always do this with commercials and consumers. For some reason, consumer debt. And you’re saying the type of debt that we go out and acquire assets that put money back into our pocket? That’s good. Ok, so let me put this another way. Using debt to buy things you can’t afford and that don’t put money back into your pocket is bad. Ok, so if I go out and buy a car, I’m buying that car because I don’t have $50000 just sitting around to go buy it and it’s not putting money back into my pocket. That’s bad debt. Yeah. Yeah, it’s not doing anything. Ok, so now if I go and buy a house and I rent out that house, I can’t afford to buy the house in cash. So I take out some debt and I put some renters in that house and now it’s paying for the mortgage and it’s putting cash in my pocket. That’s good debt. Yes, it’s paying for itself. Yeah. Ok, now here’s let’s get into the nuance now. What if I buy a house? I can’t afford it, so I take debt, but I live in it. And so it’s not putting cashback in my pocket, but I am paying down the mortgage. Is this good debt

Dan Krueger: [00:03:27] Or is this bad debt assuming you can afford it? And the appreciation is going to outweigh the cost of the interest? Yeah, it’s. It’s fine, it’s fine,

Anthony Vicino : [00:03:38] It’s it’s fine. And this is an important thing that I pointed out because this is a hot topic. I think for a lot of people when it comes to your primary residence is it an asset, is it a liability? Ok, it’s not an asset in the sense that it’s putting cashback in your pocket, but it’s also it probably maybe is appreciating so and if nothing else, maybe you are paying down the mortgage, so you could kind of look at it as an asset. But here’s the thing we ought to be a great investor. You need to understand how to leverage the different types of debt advantageously. And if you’re looking at your primary residence and thinking that’s the most advantageous use of your capital, then you’re not really thinking about your capital in the right way. So that’s.

Dan Krueger: [00:04:19] That’s my challenge to you. Yeah, and I’m thinking now that we’re actually doing this episode. Given the current situation with inflation and lower interest rates are, I got to say that some of the things that I would have previously thrown in the bad debt category might actually not be quite as bad and might be in that fine category now.

Anthony Vicino : [00:04:37] Like what? Tell me what? Like a car at like zero percent?

Dan Krueger: [00:04:42] No, I’m just thinking about, you know, it’s just, I mean, if you’re in someone’s offering you money at three percent, regardless of what you’re going to do with it like. Take it like, I mean, assuming like obviously try to do something good with it, but like I’m just trying to like kind of think this through in real-time like when someone’s giving you, let’s say, $100000, they’re going to charge you three percent interest and the money you’re paying back is going to be worth seven percent or less because that’s what inflation is. Then it’s almost dumb not to do it. And I feel weird saying that. I don’t think I should be saying that to people because I don’t want them to actually just go and start taking out loans. But the finance geek in me knows that that makes sense all day long. But I can’t in my right mind and anybody do it.

Anthony Vicino : [00:05:29] Here’s here’s how. Here’s how to do it. Here’s how you here’s how I actually think about good debt bad debt. It’s not really about using a credit card because I use a credit card to buy everything and I pay it down a month later, right? And this is how a lot of businesses operate with like a 30 or 60 or 90 days accounts payable system, right? Like we’re trying to delay when we have to pay on things. So the question really is what’s the highest and best use of your capital and use debt accordingly, right? Like, the credit card allows me to use my capital more effectively because it allows me to delay everything by 30 days. And knowing the time value of money. And I get points like, yes, there are other great things there. And so. When we’re looking at the highest and best use, we have to take into account interest rates and payback terms, and so this is just it’s a lot more complicated than simply saying debt is bad, right? And or and it’s also not as simple as just saying use debt to go out and acquire cash-generating assets. It’s really about what’s the highest and best use of your capital. And does the debt facilitate that?

Dan Krueger: [00:06:37] Mm-hmm. Yeah. And then something else is just food for thought for people who aren’t in like the ultra-high net worth category because we’re not but speak for yourself. We study this stuff a lot. We read a lot about it. We learn a lot about the types of people who are in that category. And something to note is that the amount of debt utilized by the extremely wealthy out there is extremely high, largely because they have all of their wealth typically in some kind of asset, and it doesn’t make any sense to start liquidating things in order to go make a purchase. So they’re constantly taking out loans against equity holdings, properties, anything that they have. They typically will use debt to facilitate, and they pay a little bit of interest to do that.

Anthony Vicino : [00:07:23] But it’s a tax-free, typically a tax-free exchange, right? And so it’s super powerful.

Dan Krueger: [00:07:28] Why would you sell like if you’re Bezos and you’ve got, you know, billions of dollars in Amazon stock, are you going to sell a bunch, take a tax hit, and pay commission to go and buy a thing? Or are you going to go and take out a, you know, at that level, probably a one to two percent loan on your holdings to go facilitate a purchase you want to make? You’re going to do the latter right. It makes perfect sense. So just kind of food for thought that the people with the most money in the world use debt heavily, right? Not because they need the money. They do not because they need

Anthony Vicino : [00:07:59] The debt of highest, best, you know,

Dan Krueger: [00:08:00] The capital, the highest and best use of their capital. It’s the most efficient way to do so.

Anthony Vicino : [00:08:03] And so all that’s to say, I don’t know if this episode actually simplified or helped the conversation. Maybe it just gave you a new frame for considering this, but it’s not so cut and dry and binary black and white to say this type of debt is good and this debt is always to be avoided. It’s not like that, and you have to look at your unique situation and what you’re trying to accomplish, and what your capital could do for you and put it through the different scenarios and stress. Test it and say, Is this the highest and best use, or is this? And that’s really what I think debt is about is applying stringent investment fees. Cc sounds gross thesis. Yeah, OK. Anyway, Stephanie, not that last one. That’s going to be it for me, guys. I’m sorry to have done that to you and put the thesis into your head. I hope you can forgive me. If you can please go over to iTunes and leave a review and tell me you still love me.

Dan Krueger: [00:09:00] So I’m sorry we lost a lot of listeners.

Anthony Vicino : [00:09:04] Yeah, that right now. All right, guys. Well, we’ll see you next week. We appreciate your listening. Real.

Dan Krueger: [00:09:09] Sorry, it won’t happen again.

Anthony Vicino : [00:09:13] Won’t ever happen again. I hope this episode was at least a little bit illuminating. Give you a new framework for considering debt. Now get out there and I don’t know. Right? Rack up some debt. I’m Scott. This is not financial investing advice. Don’t do as I say just, you know, this is educational entertainment purposes only. Ok, go buy.

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