How Debt Helps You to Build a Property Portfolio | Part 2



In the first instalment of this blog we explained why using leverage and debt can help you to grow your property portfolio much more quickly than if you remain debt-free and simply invest what you have (if you haven’t read the first half of this article and would like a bit of background on using debt and leverage to fund investments you can read it here.) In the second instalment we will explain the difference between the three main types of debt, and why choosing wisely is important in order to maximise leverage and in turn increase the profitability of your portfolio.

On the face of it using leverage may seem like a straightforward no-brainer - a simple, quick and easy way to maximise your profits as a property investor – but it does come with caveats and risks attached. We tend to think of all debts as bad – so changing this perception and looking at debt from a broader financial perspective is key. For these reasons it’s important to understand as much as possible about the different types of debts available, and how your choice could affect the outcome.

 

Debt 1: Horrible Debt

‘Horrible debt’ refers to debts taken out against assets that will decrease in value over time. Types of ‘horrible debt’ include personal loans and credit cards – you’re borrowing against nothing, and the interest will increase without profits generated to cover it. The types of things you’d usually finance using loans and credit cards (family holidays, a new car, fancy clothes, home improvements etc) are best funded with cash savings.

 

Debt 2: Tolerable Debt

‘Tolerable debt’ refers to debts you generally need to acquire that do actually offer you something you need in return. For example, the debt you used to buy your family home, or a new family car. It keeps a roof over your head and gets the kids to school – but it’s not actually making you any money. It’s known as ‘tolerable’ because although your property is going up in value and you are benefiting from it, you are the one paying for it.

 

Debt 3: Productive Debt

This is the type debt you’ll want to become acquainted with as a property investor. It refers to the purchase of income-producing assets – properties that are likely to increase in value bought via debt which increase your profits in the short and long term. The beauty of this kind of debt is that unlike tolerable debt, you’re not the only person responsible for repaying it. In this situation, rental incomes and tax concessions take care of your repayments for you – so you contribute nothing, or a very small amount. When debt is tolerable you pay it all.

 

The bottom line? Taking sensible, calculated risks with productive debt could help you to triple, quadruple or increase your portfolio’s profitability ten-fold, whilst maintaining complete control of your assets.

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