Understanding the nature and types of debt is an important first step for any property investor. Instead of being something to be afraid of, the right debt can be a good friend.

Most property investors use debt to finance their investments. It’s a key element in maximising the tax effectiveness and overall returns of a project. The debt is offset against the value of the asset, which is why the banks are prepared to provide the finance against the property. This represents ‘Good debt’, as the interest is tax deductible and the debt is used to acquire and hold assets. Those assets in turn produce income as well as capital growth over time, which is obviously a good thing.

So-called ‘Bad debt’ is the non-tax deductible kind that gets used to buy goods or services that don’t produce an income. (The family home is an exception). The kinds of purchases that create bad debt are items like cars, boats, and clothes that depreciate in value the moment you leave the store. Even as they lose their value, you continue paying off the full price, plus interest, into the future.

Investment property is regarded as an application of good debt. An investment property increases your net wealth over time and helps you achieve a financially secure future. The mortgage that you need to buy the property is a cost that is tax-deductible, along with the other costs needed to run the property.

This means that aside from the contribution of the tenants’ rental towards meeting the cost of the debt, the tax deductibility means that the government supports you as well. So the tenants and the government help you to meet the monthly holding cost of the loan. With the holding costs thus taken care of, you are free to hold on to the property and enjoy the capital growth over time.

Figures for the past 40 years show that on average, property values double roughly every 8 years. This means that an investment property purchased today for $380,000 could be worth as much as $760,000 after about 8 years. This is a great increase in your net worth, all made possible by ‘Good debt’. This is why property investors use it for this purpose.

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