\“Should I pay down my mortgage(s) or invest in new rental properties?”
Nor does that question end with mortgages and new investment properties. When should you pay down student loan debt, and when should you invest in equities? When should you pay down credit card debt vs. investing in, well, anything?
For that matter, what’s good debt versus bad debt? Or is there even such a thing as “good debt”?
Leverage – the ability to invest using other people’s money – is one of the great advantages of real estate investing. But as we know from Spiderman, with great power comes great responsibility.
Debt comes with risk, and risk must be managed. Here’s a framework for thinking about debt, investing, and how to balance the two by knowing when to aggressively invest and when to focus on paying down debts.
Good Debt, Bad Debt, Credit Card Debt
I’m a fan of Robert Kiyosaki’s definition of good debt versus bad debt:
“Good debt puts more money in my pocket every month. Bad debt takes money out of my pocket every month.”
It doesn’t get much simpler than that.
If you borrow money to buy an income property, and it produces $200/month rental cash flow for you, then that mortgage is good debt.
If you go $2,000 into credit card debt to buy a bunch of new furniture for your home? That’s bad debt.
Which brings us to an important point about credit card balances: it’s almost always bad debt. That doesn’t mean credit cards don’t have their place; they’re useful for rewards, if you pay the balance in full every month.
You can even use credit cards to buy real estate!
But credit cards tend to have usuriously high interest rates, if you don’t pay the balance in full each month. If you’re paying 12-22% in interest rates to borrow money from credit cards, and can expect an average return from stocks or rental properties of 7-12%, then it’s a no-brainer: pay off all credit card debt before investing a cent anywhere else.
I bought a rental property using credit cards once. It worked like a charm – but I made sure I paid off those credit cards as my first priority once I had the property under ownership. I put every penny I had toward paying off those credit cards, and within a few months they were paid and I owned the new property free and clear.
Always pay credit card debt off before looking anywhere else!
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Expansion Cycles
When I plan out what to do with my money, I think in terms of cycles.
To grow my investments, I start an expansion cycle. I aggressively invest money in equities, rental properties, and occasionally other investments like private notes.
My goals are twofold: 1. Expand my income, and 2. Expand my net worth.
Those goals work hand in hand with one another in most cases. A new rental property expands both my monthly income and my net worth. Mutual funds that pay dividends do likewise.
In an expansion cycle, I’m not afraid of taking on debt to expand my income and net worth. After all, good debt puts more money in my pocket every month, right?
So why not always be expanding? Why stop?
Consolidation Cycles
The time comes periodically for everyone when they need to pause and take stock. To evaluate their progress. To decide what to do next.
And often, to pay down debts.
There are a dozen reasons why we all need a financial breather sometimes. Perhaps the market starts free-falling, and we don’t know where to put our money.
Maybe retirement is approaching, and we want to trim our debts beforehand. Or you find out you’re expecting a baby, and suddenly start thinking about creative ways to pay for college.
Sometimes, life just throws a curveball, and we need time to reassess.
In these moments, I stop buying new investments, and either set aside money in cash, or pay down debts.
When I tackle debt, I typically follow the debt snowball method – pay off the smallest debt first, then apply the savings to the next smallest debt, and so on.
It’s a great way to pull back when I’m feeling overextended, or am feeling uncertain about where the market is headed.
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“Provocative” as always Brian! I’m hoping to expand over this year, then re-evaluate at the beginning of next year. I want at least one more rental property in my portfolio this year!
Sounds like a plan Cara! As always keep us posted on your progress and questions 🙂
Great framework for thinking about your money, and setting short-term plans that align with your long-term goals.
Good article. Too often we are pushing ourselves on the more, more treadmill. Reflection is often necessary. The other great thing about paying off mortgage debt is that not only are we making a interest rate percentage on our returns but we are increasing our returns on that investment by the payment that is now gone. . I have more than once suggested to investors w 100 properties or more to sell half and have half free and clear. If they run the numbers they are as good or better with fewer free and clear.