How I Use Good Debt to Pay Off Bad Debt

Debt is a very important topic when it comes to financial well-being. And the reason is simple. Most people, doctors included, don’t understand the difference between good debt and bad debt, let alone how to use good debt to pay off bad debt. As a result, most people accumulate bad debt. And this severely restricts their ability to achieve financial freedom.

In fact, I’ll go so far as to say that it is impossible to achieve financial freedom while holding on to bad debt. And don’t even get me started on interest arbitrage…I’ve already discussed that here.

My goal here is to share an extreme example of the difference between good debt and bad debt. And that is the story of how I use my good debt to pay off my bad debt.

First, some definitions…

I’ll borrow my definitions from Robert Kiyosaki in his book, Cashflow Quadrant.

So, what is good debt?

Debt is good if you are compensated or paid for taking it on.

You may be screaming at the computer or phone screen right now saying that this is not possible. When we borrow money, we have to pay interest on top of the principle. So, how the heck would we get compensated for the debts that we take on?

I’ll answer this all important question a bit further on. Stay with me.

What is bad debt?

Well, it’s the inverse of good debt.

Therefore, it’s debt that you are not compensated or paid to take on. I would venture to guess that most of the debt that most physicians think of fall into this category.

And here are some examples…

I’ll start with bad debt. Bad debt includes:

Student loans
Credit card debt
HELOCs
Mortgages on your primary home
Car loans

As you can see, most debt is bad debt.

So what then is left over? Well, good debt includes:

Mortgages on cash flowing real estate
Start-up debt for cash flowing businesses

And, that’s pretty much it. I even hesitated putting that second example up there because most small businesses will fail before they become profitable. So the caveat that the business be cash flowing is very important. And you can’t know that ahead of time.

On the flip side, real estate is something that can much more reliably cash flow. And we can be pretty sure ahead of time if that will be the case before we buy a property so long as you screen and analyze potential properties the right way.

As we see from these limited options, they are only good because the cash flow from the thing that you are taking on debt for (let’s stick to real estate) pays for the debt service and then some on top. And that extra cash on top goes into your pocket.

That’s how good debt pays you for taking it on.

From exploring this, a few important concepts emerge related to our journey to financial freedom

To reach financial freedom, we need to get rid of bad debt
The quicker we get rid of bad debt, the quicker we get to financial freedom
Good debt results in cash flow (money in our pocket)
The more cash flow we have, the quicker we get to financial freedom (here is why)

And one final thing…

5. You do not need good debt to reach financial freedom. You can do it without. However, you do need to eliminate bad debt to reach financial freedom.

With this all in mind, let’s get into my example…

Based on the fundamental tenets above, if we combine these wealth building strategies, we can really accelerate our path to financial freedom.

And this is exactly what I do. Especially over the past year.

People often ask me how our real estate investing strategy has changed over the past year or so given higher interest rates

And my answer is that our real estate investing strategy has stayed the same.

We still invest in multi-family rental properties in the Buffalo, NY area with expected cash-on-cash returns of greater than or equal to 10%.

However, with higher interest rates, the number of properties meeting this criteria have decreased. Not evaporated. But definitely decreased. And we are in no rush. We know the tortoise beats the hare in real estate investing.

We have no plans to expand our criteria. Remember, there are no called strikes in investing.

As a result, in 2023 we bought only one rental property. And in 2024, we have not yet bought another as of this writing.

Thus, since our accumulation of good debt slowed, we felt it made sense to focus even more on eliminating good debt

Up until 2024, we used all of our revenue from real estate investing to invest further in real estate. (Well, with one exception…) But this left us with a surplus as the rate at which we bought properties slowed with rising interest rates.

The debt on our properties remained good. It kept paying us for taking it on every month. Our net worth increased and we progressed along our path to financial freedom.

I’m a bit embarrassed to say it took me awhile to recognize the power of paying off my bad debt (student debt) with this good debt. But we started doing this in the past 6 months.

How it works

Basically, we keep an emergency fund in our real estate bank account of at least $1,000 per property.

Anything in the account beyond that amount, we use to pay off our student loans. Remember, at this point, my federal loans still qualify for PSLF. So I don’t pay extra to the federal loans now.

However, I had private loans (all of which are now paid off) and Selenid has private and federal loans that do not qualify for PSLF. In total, we have paid off around $60,000 worth of bad debt with our real estate cash flow.

So we continue to pay those loans off with the cash flow made via real estate.

This is like a virtuous cycle propelling us towards financial freedom. We make good debt and pay off bad debt simultaneously!

But wait…what about the money we used to buy the rental properties?

This is a very valid question.

For each property we buy, we have to make a down payment (usually 25%) plus pay closing costs and any immediate repair/renovation costs.

What if we just used that money in the first place to pay off bad debt? Wouldn’t it all be gone by now?

And the answer to that question is…yes.

The total money out of our pocket for each rental property we bough so far is around $60,000. If we used that money to just pay off our loans, we would be student debt free right now.

But…and there is a big but…

That would be it.

The money cycle ends there. It pays off the loans and stops there. There is no cash flow or future money power.

However, doing things my way…using good debt to pay off bad debt…creates a constant cash flow and cycle of money. Our money now has velocity…

I buy an asset that cash flows. I use that cash flow to pay off bad debt. The asset than keeps cash flowing. And now that (future me) is debt free, I can use that cash flow however I want.

That’s powerful.

Plus, keep in mind that cash flow from previous real estate properties paid for newer properties that now also cash flow. That’s how we got to a portfolio that cash flows $10k monthly…

What should you do?

Well, you have to do what is right for you and what aligns with you values and helps you achieve the financial goals you created.

Good debt in the form of real estate investing does not need to be a part of that plan to be successful.

However, it can be a very powerful part of that plan if you want it to be. There will always be naysayers who cite the risk involved with real estate investing. And there is risk. But there are ways, like anything, to manage and mitigate that risk to be very successful.

And then you can couple your power to harness good debt with the ability to amplify your elimination of bad debt. Before you know it, financial freedom will be right around the corner!

Here are some other great resources and information about the intersection of debt and investing for financial well-being:

What do you think? Do you agree that there is such a thing as good and bad debt? Should good debt be used to pay bad debt? Have you done this? Let me know in the comments below!