Isn’t it interesting that we can now see the “silver lining” in this catastrophe? I am about to show you how you can find similar beneficial outcomes if you have debt, which is typically a financial catastrophe. We would never plan Titanic sized tragedies for the sake of what we could learn from them, but when they happen, we try to make the best of the situation. Similarly, I am not advocating Titanic size debts as a means of benefiting financially, but if you have debts, let’s see how they could be your greatest wealth opportunity. Just to be clear, those who have no debt have greater wealth opportunities than those with debt, but for those who already have debts, let’s see how to turn that situation into something worthwhile.

Debt: The Good the Bad, and the Ugly

According to Creighton University’s Center for Marriage and Family, debt is the leading cause of strife for the newly married. That’s one huge reason to get out of debt, and it’s a strong indicator that having a solid wealth building plan can have the opposite, very positive, effect on your most intimate relationship. In general, debt is the death of wealth! Paying interest on borrowed money is the antithesis of investing; it’s your money working against you instead of working for you. That being said, some debt works against you more powerfully than others. We’ll call the least offensive kind good debt but note that it is not always good.

The two most common types of debt most people are familiar with are a mortgage and a car loan. These represent one type of good debt and one type of bad debt. The key difference is quite simple: Good debt applies to appreciating assets, and bad debt applies to depreciating assets. We can go one step further and talk about ugly debt. This is the worst possible kind, where there is no asset of any value attached to the debt at all, just payments on borrowed money that has already been spent and cannot be recovered by selling an asset.

Good debt is misunderstood by a lot of people, and the concept is virtually never taught in school, not until university business classes at least, and even then it applies more to corporate debt than personal debt. It is considered common knowledge in our society that you should always pay off your mortgage as quickly as possible so you can have more discretionary cash for living the good life or saving for retirement.

For most people, with typical education and investing experience, that is good advice because at least it’s safe. That’s because a mortgage is not always debt on an appreciating asset. In fact, the underlying cause of the 2008 global financial crisis was the incorrect assumption that real estate always increases in value. A mortgage is only good debt if it is structured in a way that ensures you will never owe more than the property is worth, so you can own it long-term.

For someone with the right financial wisdom, a mortgage can be considered as good debt. A properly structured mortgage isn’t a simple debt, it is just the portion of the value of a durable asset in the liabilities column of your net worth calculation. Remember that your net worth is the sum of your assets minus liabilities. Real estate generally retains or gains value over long time periods so a mortgage can be arranged to ensure you always have some positive equity even if housing prices fluctuate. In this case the asset value will always be greater than the liability in your net worth calculation.

Structuring such a mortgage usually means a down payment of 20% or more. The idea is that you own outright the equity portion of your house, and that equity can grow over time due to two factors: 1) asset appreciation, and 2) paydown of principle. Also, a mortgage is about the cheapest means of borrowing money you will ever find because the risk to the lender is minimal if you have made a good-sized down payment.

The total value of your house, not just your equity portion, fluctuates along with the housing market in your area. That’s a form of leveraging money in a real estate investment, and the risks are very low as long as you have adequate income to make the mortgage payments. Any funds you would otherwise have used to pay down your mortgage faster than required can be put into alternative investments, and now those funds can earn money for you at the same time. The net result is two simultaneously appreciating assets: the equity in your real estate, and your investment portfolio. If structured safely, mortgage debt can definitely be a wealth building opportunity.

Let’s look at a quick and easy example to see how much this good debt could be worth in terms of asset appreciation. If you bought a $500K house with a 20% down payment, plus 5% closing costs you would have to come up with an investment of $125K and acquire “good debt” of $400k. The costs of your mortgage interest, insurance, property taxes, utilities and maintenance would be similar to what you would pay alternatively to rent a place to live, so they can be excluded from this rough calculation.  If the real estate value increased over the long term at about 5.5% annually, which American residential real estate has done historically, on average, over the last 60+ years, your $125K investment could turn into over $3 million after 35 years.  Your ROI would therefore be 2400% over 35 years, or a 9.5% Compounded Annual Growth Rate (CAGR). Your real estate investment would grow much faster than the real estate itself precisely because you had good debt (your mortgage) leveraging your down payment. You only invest $125K but you experience the growth of a $500K asset.

Bad debt is debt on depreciating assets, like car loans. These debts should be avoided if at all possible, and if they are unavoidable, they should be paid off as quickly as possible. Car payments rob you of funds that could otherwise be working for you. With a car loan, or debt on any other depreciating asset, at least there is the possibility of selling the item and paying off the debt, but with depreciating assets it’s very easy to owe more than the asset is worth. It is therefore paramount that you aggressively avoid debt on assets of this type. (There is another definition of bad debt, which is simply the idea of a loan where the borrower cannot pay it back or even make interest payments. That is bad debt all right, but it’s not the sense in which we are using the term here. We are just contrasting bad debt for depreciating assets vs. good debt that is inexpensive, low risk, and tied to an appreciating asset.)

Ugly debt is where there is no asset at all associated with the payments that must be made. You should never get into any debt of this nature. If you already have, use all the income-generating and cost-cutting principles to find ways to get rid of that ugly debt ASAP before you even begin to get money working for you.

Examples of ugly debt are credit card debt (which is any amount you can’t completely pay off with every monthly statement), personal loans where there is no underlying asset tied to the payments, and worst of all, anything like debt to family members, friends or gambling debts. If you have any ugly debts, you already know what they are so you must take immediate action to eradicate them and commit to never going into debt of this kind again.

There is one type of debt that falls outside all these categories and that is student loan debt. This debt is hopefully associated with an underlying asset, and it does have monetary value; it’s your education. This is an asset because you should be able to sell it in the form of a higher-paying job. Presumably your education will make your services more valuable, but you won’t instantly recover the costs you incurred to earn that education.

If you still have student debt at this stage of your life, calculate the interest rate on the loans and compare it to what you could be making in investments. The interest rate on most student loans is fairly low. If your investment returns are safe, and substantially higher than the interest rate on the debt, it may be ok to pay off any student loans slowly and invest as much as possible instead.