Don’t Cut Expenses. SPEND! SPEND! SPEND!
There are many reasons that I don’t join the bandwagon of people ordering you to “cut up your credit cards, get out of debt, and live below your means!”
I don’t say those things because I don’t think that advice solves the problem for anyone who wants to become wealthy.
For people who want to have a lot of money and enjoy the lifestyle that money can bring, simply cutting up your credit cards and getting out of debt does not solve that problem, nor does it necessarily make people happy.
On just basic financial principles, I do agree that cutting up your credit cards is good advice for most people.
But simply getting out of debt does not work for anyone who wants to become wealthy and enjoy life. If a person wants to become wealthy, a person needs to learn how to respect the power of debt, know how to get into more of the right kind of debt, and learn how to harness the power of debt.
If people are not willing to learn how to respect and harness the power of debt, then cutting up their credit cards and living below their means is great advice.
But for those who want to exit the rat race and find true wealth, there’s another way…
Good Debt Vs. Bad Debt
When it comes to good debt versus bad debt, let me repeat what rich dad often said to me:
“Every time you owe someone money, you become an employee of their money.”
That is, if you take out a 30-year loan, you’ve instantly become a 30-year employee for the bank. Unfortunately, they don’t give you a gold watch when the debt is retired.
Rich dad did borrow money, but he did his best to not become the person who actually paid for the loans.
That is the key.
His advice bears repeating:
Good debt is debt that someone else pays off for you…
Bad debt you pay for with your own sweat and blood.
His love of rental properties was based on the idea that “the bank gives you the loan, but your tenant pays it off for you.”
Let me use a typical real-life example to illustrate just how this works. Assume that you find a nice little house for sale in a decent neighborhood. True, the home needs some fixing up — perhaps a new roof, new gutters, and maybe a new paint job.
But by and large, it’s surrounded by other homes that are fairly well maintained, the neighboring area is solid, and the schools are good. Even better, the neighborhood is right next to a local state university which is always looking for more student housing as the campus enrollment continues to increase year after year.
The homeowner wants to retire and move to someplace warm and sunny. He’s asking $310,000 for his house. You negotiate a bit with him, and you finally settle on a price of $300,000. You already have $10,000 saved up in your bank account, so you need to get a mortgage for at least $290,000.
But in truth, since that $10,000 is pretty much all the cash you have on hand, you decide to apply for a $300,000 mortgage. Why? Because with that additional $10,000, you can pay off the bank’s closing costs as well as pay a local handyman to paint the house and repair the roof and gutters.
Under current finance rates, the bank gives you a 30-year mortgage at a rate of 2.5%. First, of course, they want that $10,000 cash as a down payment, which you give them. So, in addition to the $100,000 mortgage, your total investment is now $110,000.
Once you figure in your property taxes, your monthly mortgage payment is going to be about $1,700.
But as mentioned before, you don’t want to be an employee of that bank loan for the next 30 years. As long as you have that debt service, you’re working for the bank. The better approach is to have someone else pay off that debt for you.
Let’s say that you charge $2,000 a month for the rent. For a small monthly maintenance fee, many real estate agencies will not only find a renter for your property but will also take care of any minor maintenance issues, such as fixing a clogged toilet.
Here’s more good news. If your rental property is earning you $2,000 a month, and your mortgage payment is only $1700, then your monthly net cash flow is $300 a month.
This net income is what is known as passive income. That is, you’re not doing any heavy lifting or hard labor to earn it. At the same time, someone else, your tenant, is paying off your 30-year mortgage for you, and you’re earning an extra $300 a month.
Rich dad’s real estate investing philosophy is primarily based on this exact type of cash flow.
Time to Buy a New Car
My wife Kim drives a beautiful Mercedes G550 SUV. Among other cars of mine, I drive a Rolls Royce.
Even when we were broke, we drove a Porsche and a Mercedes… or other nice cars. We did not pay cash. We borrowed money to buy them.
Why? Let me explain with the following story, a story I often tell. It is a story about good debt and bad debt and enjoying the finer things of life.
In 1995, I received a phone call from my local Porsche dealer. He said, “The car of your dreams is here.” I immediately drove down to his showroom to look at a 1989 Porsche Speedster.
I already knew that there were only 8,000 of this model made over a three-year period. In 1989, Porsche devotees were buying them, putting them on blocks, and storing them. If you could find a collector who would sell one, the asking price was $100,000 to $120,000.
But in 1995, I was looking at the rarest of all the 1989 Porsche Speedsters. This was Speedster Number 1, the first-ever built of this model, and it had the Porsche turbo body, which means little except to a dedicated Porsche fan. Since it was the first one built, it was the model that the factory toured all over the world at auto shows and was the car used for the photo on the brochure.
The car also came with a special plaque from the Porsche factory. After the tour was over, this car was also put up on blocks and stored in a warehouse. When a collector decided to sell it in 1995, the dealer called me. The dealer knew it was the car I had been looking for. The car may have been used, but it only had 2,400 miles on it.
Kim watched me go into a hypnotic state as I walked up to the car of my dreams. I sat in the car, took hold of the steering wheel, and inhaled deeply, smelling the rich scent of leather, which was still with the car. The car was absolutely flawless, and the color was perfect… a shade Porsche calls “metallic linen.”
Kim looked at me and asked, “Do you want it?” I responded with a nod of my head and a smile.
“Then it’s yours,” Kim said. “All you have to do is find an asset to pay for it.” Again I nodded, inhaled the rich scent of leather one more time, climbed out of the car, and smiled. It was the car of my dreams. We put a deposit on the car, arranged the financing with the dealer, and went out to find the asset that would pay for the car.
In other words, I was going to find an asset to pay for my liability and use good debt to pay for the bad debt.
A little over a week later, I found a great piece of property — a mini-storage project in Texas — borrowed money to buy it, and the monthly cash flow from the property covered the monthly car payments for the Porsche.
Five years later, the Porsche was paid off and I still had the cash flow from the property. Instead of getting poorer from having an expensive liability, I became wealthier and got the car of my dreams.
Instead of saying, “I can’t afford it,” I said, “How can I afford it?”
I encourage you to do the same.
Editor, Rich Dad Poor Dad Daily