Rich Dad Scam #7: Get Out Of Debt image

Rich Dad Scam #7: Get Out Of Debt

Lots of people will tell you how to get out of debt, but you need to know how to use debt instead

This is the seventh post in a series I’m calling Rich Dad Scams, which are lies perpetrated on the poor and middle class by the rich. If you’ve been following along with the series, you may see some patterns in Rich Dad Scams. Several of them go together, and they all come from the same mindset. Saving money, living below your means, and this Rich Dad Scam, “Get out of debt,” all come from one place: fear of money.

Just like all the other scams, the idea that you have to get out of debt and stay out of debt to be successful is a lie, and it gets repeated because people don’t have a financial education. They simply don’t really understand what money is, how it works, and how to put it to work.

“You should get out of debt because it’s bad”

The number one reason why the so-called experts will tell you to get out of debt is because they believe debt is bad—for you.

Remember, the Rich Dad Scams we identify are the ways the rich stay rich and make sure the poor stay poor. That can be counterintuitive, especially when some of the scams, like getting out of debt and saving money, seem like they would help you get rich. But that’s the scam.

The rich carry debt. They generally carry a lot of debt. But they have assets that more than make up for the debt they carry. In fact, the rich not only carry debt, they also use it to get richer. The rich know that if everyone understood debt and how to use it to get rich, they’d have more competition for the assets they buy with that debt to get rich. The rich and so-called financial experts also think they are the smartest people in the room. So, they think that for most people, debt is bad because to them most people are too stupid to use debt the right way to get rich.

But they speak out of both sides of their mouths. They talk about how debt is bad and how you should get out of debt, but they also make their money off of selling the poor things that they take loans out or us credit cards to pay for. Things like cars, vacations, clothes, TVs, houses, and more.

Ultimately, the difference between the rich and poor when it comes to debt is understanding the difference between good debt and bad debt. The Rich Dad Company exists to help level the playing field. That’s why we expose Rich Dad Scams like “get out of debt.” Instead, we want to teach you about the difference between good debt and bad debt.

Get out of bad debt and get into good debt

Bad debt is debt that makes you poorer, such as credit card debt, car loans, and more. This is the type of debt used to buy liabilities. Ironically, this is the debt that those who say debt is bad get rich from by selling to the poor.

Good debt is debt that makes you richer, such as a loan for investment property or to purchase equipment for your business that will make you a return. This is the type of debt that is used to buy assets. The rich use this kind of debt to buy assets or create products that they sell to the poor, who often take out bad debt to buy them. Perhaps you’re seeing how this works?

An easy example of good debt is my real estate holdings. By getting a loan from the bank, I can purchase a property with only a small percentage out of my pocket, at the most 20% but sometimes much less. I then rent that property and my tenant pays the cost of the debt while putting money in my pocket.

I wrote in detail about this awhile back in a post called, “What is Bad Debt? (And How To Use Good Debt Instead)”:

For example, in real estate, I can buy investment properties with debt. The bank will give me a loan for 80 percent of the purchase price while I only have to use my money—or someone else’s—for 20 percent of the purchase price. My job is to find a deal that pays the bank the interest on the 80 percent while still providing a decent return on my 20 percent.

So, using simple math, if I have $100,000 in cash, I could buy one property for $100,000 that gives off $800 a month in cash flow—a little over 9% annual return.

Or I could use good debt to buy five $100,000 properties. The bank would lend me $80,000 for each property and I would divide my $100,000 into five $20,000 down payments. At 5% interest, the payment on the loans would be around $500. So, my cash flow on each property would be $300 a month ($800 in rent – $500 in debt payment = $300 per month) for a total of $1,500 ($300 x 5 = $1,500) per month—an 18% annual return. That is twice as much as if I’d only used my own money to invest.

Business is the same as the real estate example. You have good debt that pays for itself. The cash flow of your business covers the debt and generates income. That income can be turned into more good debt to create more cash flow.

We’ve been taught to think of debt as a four-letter word, but it doesn’t have to be. Especially once you have the financial education to see how it can work for you instead of against you.

Now, getting into good debt can be hard if you’ve dug a hole for yourself with bad debt (but it’s not impossible). So yes, it is important to get out of bad debt, but only so you can begin to invest with good debt. The goal should not be to get out of debt completely and for good.

How good debt makes you richer

I have an excellent example of how the good debt concept works. Say I have $100,000. Maybe I inherited it, or sold something valuable. But I have this money. I can put it into a mutual fund, which is a little better than saving it. The return on it would be a bit more than just putting it in savings, but it won’t be a lot.

However, if I use that $100,000 as a down payment on a $500,000 property, then I’ve actually bought $500,000 in value with just $100,000! The difference, that $400,000, is good debt. Like my example above, if I play my cards right, that property can cash flow. So not only have I expanded my wealth by putting a $500,000 asset in my asset column with just $100,000, but I can also realize positive cash flow each month and my tenants pay down my debt for me!

This is exactly what my wife Kim did on a smaller scale with her first investment. She bought a $45,000 house with a $5,000 down payment, acquiring $40,000 in good debt, and she put that property to work. The tenants paid the mortgage and the taxes on it for her. She was profiting, or generating a positive cash flow of $25 a month. It wasn’t a lot, but it was a start. She used the same practice over and over again, and she kept putting that money to work. Today, she invests in millions, but the concept is the same.

Today, rather than buy into the lie of Rich Dad Scam #7, “Get Out of Debt,” I encourage you to instead increase your education and begin learning how you can make good debt work for you.

Original publish date: April 19, 2013