False definitions of debt can hold you back.
As an entrepreneur, you’ve probably read before that there’s “good debt” and there’s “bad debt.” But that’s wrong — “good debt, bad debt” is false. If you truly know what debt is, there’s no such thing as “good debt.” But that doesn’t mean there’s never a good time to borrow money. The problem is confusion about the actual definition of debt. And once you get clarity on the issue, it will free up your mind and allow you to produce on a higher level as an entrepreneur.
How False Definitions of Debt Hold Us Back
Many see borrowing money for big purchases like homes, cars, or to start a business as an evil — although a necessary evil — because it supposedly means going into debt. But this is a dangerous philosophy because now your “evil debt” eats at your conscience. It’s like a monkey on your back constantly telling you, “You can’t feel safe or free or enjoy life until you don’t owe anything to anyone.” And the associated guilt and stress harms your productivity and closes your mind to opportunities.
This false definition of debt is pushed on us from all directions. For example, if you listen to personal finance gurus on TV or on the radio or in books, then you’ve probably been told to avoid borrowing money at all costs. One guru in particular recommends paying for your house in cash up front — something even Facebook billionaire Mark Zuckerberg chose not to do — that’s how much they detest “debt.” While the finance gurus are correct about avoiding debt, they’re also wrong because borrowing money to buy a house does not necessarily put you into debt. Yes, the mortgage is a liability. But you’ve also taken control of an asset, and that can’t be ignored. And if the house is worth more than your mortgage, which is usually the case after making a down payment, then you now have something called “equity,” which is the opposite of debt.
So what is the true definition of debt? In short, debt isn’t owing money, it’s owing more than you own. The only time we are in debt, in the true accounting sense, is when our liabilities are greater than our assets. We do want to avoid true debt (having more liabilities than assets), but we don’t want to avoid incurring liabilities (owing something to someone else) that can be beneficial to our productivity, value creation, and prosperity. In fact, in many instances, the way to increase our prosperity and wealth is to increase — not decrease — our liabilities.
But here’s the catch, and where you may want to be concerned about borrowing money. Not all liabilities are created equal. For example, if you don’t currently have the means to eat at a 5-star restaurant every night, but you do it anyway and put it all on credit, then you’re creating a consumptive liability. You’re digging yourself deeper into debt, with nothing to show for it when the meal is over. If your car is constantly causing you problems, but it’s not paid off yet, it’s a consumptive liability because it’s negatively impacting your productivity. If you borrow to buy new software or equipment for your business, but never implement it, then it’s a consumptive liability. The general rule is, if the liability doesn’t add to your cash flow, then it’s a consumptive liability and is to be avoided.
On the other hand, it’s best to secure as many productive liabilities as you can. That’s because, by definition, they always leave you wealthier than before. Examples of productive liabilities may include education loans, small-business loans, a business line of credit or collateralized business loans. Another example of a productive liability for business owners is payroll. Every month the business owner ends up owing their employees a paycheck or two. But assuming your employees increase your cash flow, this is a good deal. It’s a productive liability.
Is a Mortgage a Productive Liability?
You may have borrowed to pay for the house you live in, and yet your house may not be providing any cash flow. Does that mean it’s not a productive liability? Before you start renting out rooms of your house to create cash flow, realize that your personal mortgage can be a productive liability. If borrowing the money to pay for your house frees up money to invest elsewhere and create more cash flow, then it is indeed a productive liability. That’s exactly why Mark Zuckerberg, the billionaire founder of Facebook, has a 30-year mortgage with a 1.05% interest rate. With such a low interest rate available to him, paying in cash or paying the mortgage off early would simply be irresponsible. There are too many other places he could put the money and earn more than 1%.
How to Turn Your Proper Understanding of Debt into Wealth
When personal finance gurus are encouraging you to get out of “debt” as fast as possible, they’re distracting you from what really matters. Correctly understood, debt is bad, but liabilities are essential to building wealth. Bottom line, it is not necessary to pay off your mortgage as soon as possible if there’s a better use of your money elsewhere. You do not have to feel guilty about borrowing to grow your business. And it’s OK to leverage loans to make investments in your area of expertise.
This article was written by Garrett Gunderson from Forbes and was legally licensed through the NewsCred publisher network.