A Simple Way To Use Debt To Buy Real Estate Properties and Make Money
Many people when they hear the word ‘debt’ will have an adverse reaction. A range of negative connotations are associated with debt, and not without reason. Accumulating large amounts of debt is a pitfall for so many and the consequences of this can be dire.
But many people, especially experienced investors, will be aware that there is ‘good debt’ and ‘bad debt’. The main difference between the two really comes down to how the debt is utilised. An indication of good debt is when money is borrowed to generate more income.
While the investment may not pay off straight away, the general idea is that you, or your family will benefit by acquiring the debt. Examples of good debt include education (which will further future prospects), a business, and of course, investing in real estate.
Bad debt, on the other hand, is debt that has the opposite effect, i.e., not improving your status or net worth. This is most apparent when borrowing money to purchase a depreciating asset.
While this isn’t always easy to predict, there are some general examples of bad debt, such as going into debt for clothes, consumables, and cars (although there are exemptions in these categories).
The core principle surrounding debt usage in property investment is leverage: using certain tools and resources to increase your net worth and maximising the return on your investments.
So what is the best way to create wealth using debt in real estate investing? Let’s first look at the instruments at our disposal that enable us to use debt to buy property.
Mortgaging investment properties will most likely be the first thing people think of when using debt in real estate investment. But did you know that there are multiple types of mortgages? Knowing which one is right in certain circumstances is important in property investing.
Having a fixed-rate mortgage option means knowing how much interest you’ll be paying the whole time you’re paying off your mortgage. External factors or variables won’t affect your interest rate, which will stay fixed at a certain amount.
This allows you to know exactly what you’ll be paying on a mortgage, without any unwanted surprises.
An interest-only mortgage means you’ll only repay the interest that accrues on the amount initially borrowed (i.e. the principal). When making mortgage repayments, you won’t actually be decreasing the debt. This will usually be available for a set period, and once this period has ended, the loan will change to ‘principal and interest.’
This means paying back the amount initially borrowed, which increases repayments. An interest-only loan can free up your money, as repayments remain low during the interest-only period. The cash saved on not paying back repayments on the principal can be directed to your next investment.
Before choosing an interest-only mortgage, it’s important to consider the impact of one large payment at the end of an interest-only period and consider whether this is still the best real estate investment strategy for you.
And that leaves an adjustable-rate mortgage. This is really the opposite of the fixed-rate mortgage. You’ll be loaned the money for the property at an adjustable rate, meaning the interest rate on the mortgage can change.
Adjustments in interest rates can change based on a range of factors, which will often be out of your control. While an adjustable-rate may be lower at the start, it could end up costing you more in the future.
Why it’s a good idea to use debt when buying property
The biggest advantage of using debt in real estate investing (and the most obvious) is the fact that it allows you to buy property in the first place. Most people starting out in property investment don’t have the capital to buy a property outright, and acquiring debt is the only way of owning a property.
It also allows you to invest in higher value properties which can, as an investor, give you a better chance of generating passive income through property
But using debt provides the greatest advantages for investors specifically when it comes to diversifying a property portfolio. With enough capital, you can split this amount to buy multiple properties, and mortgage the remaining amount for each property investment.
This allows you to build your property portfolio faster, and with the right property selections, diversify to increase your chance of success.
There are also tax benefits to using debt to buy property, specifically for investors. If the property is generating taxable income, interest-charges on a mortgage for an investment property are tax-deductible.
Using debt the right way
Using debt to buy property is only really effective when you’re able to maximise the return on your investment. Buying property with debt relies on you being able to pay off that mortgage, as efficiently as possible.
This will allow you to use that equity for the next deposit and build your portfolio, or have rental income go straight in your pocket rather than back to the bank. You can acquire as much debt as you like (or that the banks will let you) but you won’t see the benefit of this ‘good debt’ unless you’re making repayments.
This means buying the right property – one that is cash flow positive and has capital growth potential. Of course, this isn’t always easy. It involves a calculated, well-thought out strategy and decision-making process. Anyone can invest in property, but knowing the right stuff is crucial.
This is where developing your property investing education can be really handy. The great thing about investing in real estate is that it can be done entirely on your own. Of course, having a good mortgage broker will be handy (especially when using debt to buy property).
The right broker can connect you to a lender as well as getting the right product that aligns with your resources and goals.
Using debt to buy property is an incredibly useful tool for property investors. Most investors will use good debt at some point. It comes down to knowing which type of mortgage is right for you, as well as knowing how to maximise the opportunities that come with debt.