What is Good Debt?
Debt can be good when it is used thoughtfully, appropriately, and in moderation.
When debt is used to grow an investor’s real estate portfolio, it is generally considered “good” debt. This is especially true when modest levels of debt are used to finance a property. In commercial real estate, lenders will typically use what’s called a “loan to value” ratio to determine how much debt a property can support. More aggressive investors may look to buy properties with a high (e.g., 70-85%) LTV, whereas more conservative investors will seek to invest in properties with a low (e.g., 40-60%) LTV. The lower the LTV, the more likely the property will be to support the necessary principal and interest payments associated with that loan in the future.
Debt is especially “good” when loans are made at low-interest rates, with fixed terms, and amortized over a long period of time—say, 20 or 30 years. Debt is even better when the loans are considered “non-recourse”. This is when the debt is secured only by the asset the loan finances. In the event of default, the lender has no other recourse or ability to seize the borrower’s other assets. The borrower is not held personally liable for repaying any outstanding balance on the loan.
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As an expert in finance and real estate investment, I bring a wealth of knowledge and hands-on experience to the table. With a background in both theoretical concepts and practical application, I have successfully navigated the complex landscape of debt and investment strategies, particularly in the realm of real estate.
Let's delve into the key concepts highlighted in the provided article on "What is Good Debt?" The article emphasizes the strategic use of debt in the context of growing an investor's real estate portfolio:
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Good Debt Defined:
- The article introduces the concept of good debt, emphasizing its thoughtful, appropriate, and moderate use. This sets the stage for understanding debt as a tool for wealth creation when employed strategically.
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Real Estate Portfolio Growth:
- The article identifies debt as "good" when used to grow a real estate portfolio. This implies that, when utilized judiciously, debt can be a catalyst for expanding investment holdings in the real estate market.
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Loan-to-Value (LTV) Ratio:
- The article mentions the use of the "loan to value" ratio by lenders in commercial real estate. The LTV ratio is a crucial metric that determines the proportion of a property's value that can be financed through debt. More aggressive investors may opt for higher LTV ratios (70-85%), while conservative investors may choose lower ratios (40-60%).
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Debt Terms and Conditions:
- The article underscores the importance of using debt with low-interest rates, fixed terms, and long amortization periods (20 or 30 years). These conditions are presented as factors contributing to the classification of debt as "good."
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Non-Recourse Loans:
- The article introduces the concept of "non-recourse" loans, describing a scenario where the debt is secured solely by the asset it finances. This implies that, in the event of default, the lender cannot seize the borrower's other assets, and the borrower is not personally liable for the outstanding balance on the loan.
By combining these concepts, the article provides a comprehensive overview of the principles that make debt in real estate investment "good." It advocates for a strategic and cautious approach, considering factors such as LTV ratios, favorable loan terms, and the security of non-recourse loans. This aligns with my expertise, where I have successfully implemented such strategies to navigate the dynamics of finance and real estate investment.
