3 Essential Debt Mindset Shifts
There are many mindset shifts I had to make as a real estate investor. The central to these is my fear and use of debt. I had concerns of over leverage and creating financial disaster for my family. This may sound overly dramatic, but my husband and I built the first 15 years of our marriage with a highly conservative financial mindset. So when I began to prepare to invest in real estate, my anxiety of holding multiple mortgages began to rise. I knew, however, that I couldn't let it hold me back. Here are 3 shifts I made to my view and use of debt, have it work in my favor, and leverage it to build my real estate portfolio.
Shift One: Minimize Use of Consumer Credit
Access to credit can trick you into believing it helps with cash flow; however, use of credit can be a cash flow killer. Department stores love to entice you with point-of-sale discounts in exchange for opening a line of credit. Forty dollars off your purchase is a great deal right? And buying a new couch using 48 months same-as-cash is a no-brainer isn't it? You can enjoy brand new living room furniture and pay it off with no interest. What's not to love?
On the surface, these deals can seem like a great way to manage cash flow while allowing you to have shiny new things now. However, accumulating these lines of consumer credit, getting behind on payments, or failing to close the accounts after you pay off the balance can have a negative effect on your credit score. A healthy credit score and low debt-to-income ratio are essential tools for buying real estate. It can give you access to lower interest rates, more favorable terms, and increase your chances of having your loan approved. Be mindful of your use of credit for consumer goods. If you can delay your gratification and save enough money to buy the item in cash, your credit standing will be strengthened.
Shift Two: Manage Opportunity Costs
Just in case you think I am against use of credit, let me assure you otherwise. The low interest rate environment we have experienced for the last 10+ years has made money very cheap to borrow. When the cost of borrowing money is less than what you can make using your cash elsewhere, then you can come out ahead. Let's take a car loan as an example. You have $35,000 cash available and want to buy a car. You can either buy it with cash or with a 60-month loan at 2.5% interest. If you pay for the car in cash, that money is no longer available to you and you lose the opportunity to invest the money or pay down higher-interest debt.
The same goes for real estate. You can either use $100,000 to buy one house in cash or you can use that money to put 20% down on 5 houses. The end result is either a $100,000 real estate portfolio generating $1000 in rent or a $500,000 real estate portfolio generating $5000 each month in rent. The advantage from leveraging debt is obvious and is key to accelerating your growth.
Shift Three: Use debt to buy income-producing assets instead of liabilities
If we continue with the car example from above, remember you have $35,000 in cash that you could use to buy the car on the spot. What if instead of spending the money on a car (which will lose value the moment you drive away), you use it to put 20% down on an investment property worth $175,000 that rents for $1500 and produces a 10% margin? Even at $150 net profit each month for the life of the property, the choice can be pretty simple.
Investing in real estate will require you to have a strong understanding of debt and how to use it in your advantage. The goal for financial freedom isn't necessarily to be debt-free. Debt can be a strong ally in your financial plan when used to buy income-producing assets. But remember that not all debt is created equal and will not be viewed the same by lenders.