Good debt or bad debt?

People often come to me concerned that the return on their savings is so small now that interest rates are at an all-time low. They are therefore challenged to find a home for their money where they will attract a higher rate of interest.

When I ask, "Well, have you considered 'property' as the home for your money?" they tend to retort, "Does that only work when you have lots of money?"

This is because we are all brought up to believe that you need at least a 20% deposit to buy an investment property and then a mortgage to fund the remainder of the purchase price. Yes, this does apply when using your own funds but there is an alternative way to invest.

Robert Kiyosaki developed the idea of good debt/bad debt in his popular book, "Rich Dad, Poor Dad".

Firstly, the mortgage on your own home is considered to be "bad" debt. This means that you have to pay the amount owed on the mortgage out of your own hard-earned income over a period of (say) 25 years when hopefully your finances will be in order at all times. Sadly, many property owners will go through a period of their life when times will not always be financially sound for them. For example, it's a sad fact but at least one in three people get divorced. Many people will be made redundant at some point in their working life too. So unless, there is a safety net there may not always be sufficient income to cover mortgage payments every month for the 25 year term.

When debt is used to fund property investments it is considered to be "good" debt. "Why is that?", I hear you ask. If your property investment is a rental property, your tenants are paying for your mortgage. This debt is called "good" debt because you are investing in an income-producing asset. Once your tenants have paid their rent to cover the cost of your monthly mortgage payment plus utility and Council tax bills (if you pay for these) any remaining money is profit, having allowed a percentage of this income to cover professional fees, maintenance, insurance and tax.

Investment property is therefore an income-producing asset, while the purchase of a residential property provides accommodation but no profit (unless you rent out a spare room).

The second concern that people often have is that you need vast sums of money to be able to invest in property. The answer to this is two-fold. In the first instance you should not invest too much cash in one property but use cash to afford a number of properties in order to spread your risk and secondly, to make your money work harder for you.

Few people will have hundreds of thousands of pounds lying around in their bank account and if they do, they are surely not receiving sufficient interest at today's rates to make this a practical thing to do. This means that all property investors, however wealthy they may have been, will eventually run out of personal funds to invest unless they are educated, professional investors who therefore know how to work round this challenge.

Successful property investors offer their network of contacts a golden opportunity to generate a higher rate of return on their funds. These returns will far-outweigh those earned by leaving their money in the bank; and they will have have had the pleasure of sharing in the success of a number of property ventures without having to spend time educating themselves in property investment methods.

When investing your own funds into property it is always wise to invest in a property that can be purchased below the typical market price i.e. at a discount. If this is not possible then one should add value by increasing the number of bedrooms to provide a higher rental income. This may be achieved simply by converting a reception room into a bedroom; or by converting a loft into a bedroom. Then the property has the potential to realise additional value so that the property can be remortgaged to provide the funds required to repay the investor.

As with all investment decisions professional advice should be taken and due diligence carried out.

If you would like any advice on doing your due diligence when choosing properties in a particular area of Guildford or a general discussion on investment opportunities in the area your call will always be welcome. Phone 01483 320207.