Rule #1 Finance Blog

With Investor Phil Town

GOOD DEBT, BAD DEBT

The other day Damien left a great question in the comments, one I get asked pretty frequently – about good debt vs. bad debt, and when it’s okay to start investing.  Here’s our exchange:

Dear Phil,

You stated in one of your many post that you should get out of debt before investing. I can understand if you hate credit card debts with as high interest rate.  In my case I only got a mortgage $84,000 and a around $6,000 in debt at 2.9% interest rate.  Should I pay everything off before I start investing which will take about 10 years or can I start investing once I master the 10% solutions.  Thanks for the help,

Damien Bricka

And here’s what I say:

Dear Damien,
Your mortgage is good debt as long as it is in the ballpark of what your place would rent for after you take your tax deduction.  Let’s say your house would rent for $500 a month. (I hope I’m not offending you with that rent amount!)  You have a mortgage of $84,000 amortizing over the next 30 years at 6%.  With Principle, Interest, Taxes and Insurance (the famous PITI) your monthly house expense is about (and I’m really just guessing here) $600 a month.  About $500 of that is a tax deduction against your income.  If you are in the 15% bracket for taxes, you are saving $75 a month off your tax bill by owning the house.  That means that the real cost of your house is $600 a month less the $75 you would have paid in taxes, or about $525.  If you didn’t own the house, but instead you were renting it, you would not have a tax deduction and you would be paying $500.  That’s pretty close to what you are paying as an owner, therefore, the mortgage is good debt.

Don’t pay it off if you can make anything positive on that money because this debt isn’t costing you anything!  You would be paying it in rent anyway. And the 2.9% consumer debt of $6000 is awesome good debt, too, if AND ONLY IF you are confident you can make a solid 3 times that.  In your case that means that you need to make about 9% on the money you would have paid off the debt with.  9%, for a Rule #1 investor, isn’t all that great of a year. Okay, but not great.  So even if you are only doing okay at this, you should probably keep that debt and use their money to make more money.