Myth #7. Get Out of Debt

Now you’ve done everything that you thought should, school – check, safe and secure job – check, house – check, saving – sorta check, retirement plan – check; then the next thing you hear is “you should get out of debt!” Well those credit cards are pretty maxed out, and it sure would be nice to not have to worry about that… so you focus on paying off all you debts. Recommendations come from everywhere and now you’re focusing on paying off your house early and being debt free. Which, if we forget about myth 4, 5, and 6, sounds great! Many people have credit card debt but credit cards aren’t actually bad. Being financially ignorant is.There is good debt and bad debt. Bad debt takes money out of your pocket. Good debt puts money in your pocket. Paying off credit cards would mean eliminating bad debt if you bought things that don’t make you money. Paying off your house early is eliminating debt as well but, depending on your situation, could be good or bad debt. Here’s why. That extra money you are using to pay down your house loan lets say $500 a month is $6000 a year. What is the interest rate on your home? 3.25% 4% What is the average stock market growth…roughly 7% so if you put money into an asset that paid you 7% instead, you’d be making about 3% more annually with that same $6000. The second problem with equity is its liquidity aka how fast you can convert it to cash. Lets say you have payed the house off and want to buy another vacation home. It’s a steal of a deal but you don’t have the cash to cover that house. Option #1: You wait another 5 years to save up for that place which has now gone up about 15% while the value of your dollar has gone down. Option #2: you utilize the equity in your home by going to a bank and refinancing your home and pay cash for that smaller vacation home. Now you’re right back where you started except you have 2 insurance payments, 2 tax payments, 2 utility payments, etc.. Plus it took about a month for the appraisal of your house (more cash gone) and the appraisal and closing of house two (imagine barrel of cash on fire). Now you got the deal but you have to focus on paying down that loan again. You may have gotten a good deal but you have two liabilities now. Lets say you truly have saved or use the extra money you’ve been paying on your mortgage for a down payment on rental property that cash flows $50 a month. You did have to take out a loan but your $6000 down bought you a $30,000 house. Because it is cash flowing, you aren’t paying for that debt, your renter is. On top of that you are making $600 cash a year or 10% cash on cash which is triple what you were saving by paying off debt. Here is some of the best truths about real estate. If you have $1,000,000 to invest in mutual funds, you buy $1,000,000 in mutual funds. If you have $1,000,000 to invest in real estate, you get a $5,000,000 property. On top of that, the depreciation and tax benefits are based on the $5,000,000 not your down payment. If you think this is ridiculous, go to your bank and try to take out a loan to go buy mutual funds and make sure you tell them. You aren’t getting that loan. Another beauty in real estate is you can borrow against rental #2 and not get taxed because loans aren’t taxed, and now you have your down payment back. Are the wheels turning? So paying off debt may sound great but your paid of house, myth #6, could drop by half in value and you are out of all that equity whereas if that equity was put into other assets that are still performing, you didn’t lose all that equity.