Updated: May 16, 2020
Not all debts are the same. There are bad debts and there are good debts. When you learn to distinguish between the two, you’ll realize that living a debt-free life is not the smartest financial decision.
Bad debt is living beyond your means.
"Bad debts are generally created from a habit of living beyond one’s means and incurred to buy things that quickly depreciate or lose in value over time."
For example, you use your credit card to buy fashionable pairs of shoes, or the latest gadgets that cost more than the amount of money you have in the bank. You know that this is a bad decision because a few years later, these items depreciate in value with wear and tear and you’ll be out of style. In addition, bad debts carry a very high interest rate. The average interest rate of credit cards in the Philippines is a whopping 42% per annum (or 3.5% per month).
Good debt is multiplying your means.
Because you’re a responsible adult, you’re avoiding the bad debt scenario and any other sort of debts. Maybe you’ve thought about buying your own home but have never made the decision because you thought about the “big scary loan” down the road.
But, as I love to explain to my clients, loans actually give you a great deal of power when you understand and know how to take full advantage of it.
"Leverage, as defined, is to use something (loan) to maximum advantage (capital appreciation). This is the concept of good debt."
To illustrate this power, consider one of my condo investments three years ago. To buy the property, I used a 15-year loan at 6% interest rate per annum which I would be paying a total of Php1.8 million in interest over the entire loan term. In the same property, I have already gained a capital appreciation of about Php3.2 million (at 16% compounded annual growth rate) in just a short 3-year period. This gives me an estimated net gain of Php1.4 million for the investment (all else remaining constant) as of today. Could you imagine what my gain would be in 15 years or so?
It takes money to make more money.
"You see that leverage can be maximized through acquiring a property that appreciates or grow in value at a much higher rate than the interest rate from the housing loan."
The real estate market has been growing at a record rate, with some of my best investments and suggestions to clients growing as much as 30% over the course of its first year. And the outlook is that it will continue to grow for years to come which I thoroughly discuss in next article. On the other end of the lever, the interest rates currently offered by Philippine banks for housing loans are at historically low rates at around 5-6.5% per annum.
Take advantage of the power of leverage and start investing in real estate now.
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ABOUT THE AUTHOR
Edric Maguan is an avid real estate investor, an experienced and accredited Real Estate Broker of several top developers, and a Certified Public Accountant from University of the Philippines - Diliman. He found his passion in inspiring and empowering people to make the most out of their hard-earned money through real estate investment. Read full biography here.