Good Debt vs Bad Debt: How to Leverage Property Safely

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December 4, 2025

Good Debt vs Bad Debt: How to Leverage Property Safely

By Trent Bradley · 8 minute read

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Understanding the difference between good debt and bad debt is fundamental to successful property investment. Not all debt is created equal – some debt builds wealth while other debt destroys it. Property investors who leverage debt strategically create substantial wealth, while those who use debt poorly face financial stress and potential disaster.

Understanding Good Debt
Understanding Bad Debt
Leverage in Property Investment
Safe Leverage Principles
Red Flags: When Debt Becomes Dangerous
Strategic Debt Management
The Luminate Financial Group Perspective

Key Takeaways

Good debt finances appreciating income-producing assets like investment properties where rental income services debt and property values increase, creating wealth through leverage multiplication
Bad debt finances depreciating assets or consumption—credit cards at 20%+ interest, car loans for vehicles losing 20-30% value immediately, personal loans for holidays creating obligations without wealth-building benefits
Leverage amplifies both gains and losses—$100,000 deposit on $500,000 property gaining 5% yields $25,000 (25% return on equity), but 5% decline creates $25,000 loss (25% equity loss)
Maintain conservative 80% maximum LVR for investment properties with target 60-70% average portfolio-wide LVR providing substantial equity cushions protecting against market fluctuations
Stress-test debt serviceability modeling 2-3% interest rate increases or 10% rental income decreases, ensuring ability to sustain debt obligations through challenging periods without distress
Total debt servicing across mortgages shouldn't exceed 40-50% of gross income consistently—exceeding 50% indicates potential over-leverage requiring immediate attention
Warning signs of dangerous debt include using property equity for consumption expenses, borrowing from credit cards to cover mortgage payments, constant financial anxiety, and declining equity positions across properties
Build 6-12 months debt servicing costs in liquid emergency reserves protecting against unexpected income disruptions, property vacancies, or major maintenance expenses

At Luminate Financial Group, we help investors understand how to use leverage productively while managing risks appropriately. The goal isn't avoiding debt entirely – that would eliminate property investment's most powerful wealth-building mechanism. The goal is using the right types of debt in appropriate amounts for wealth creation while avoiding debt that diminishes financial position.

Understanding Good Debt

Good debt finances assets that appreciate in value, generate income, or both. It's debt used strategically to build wealth over time.

Characteristics of Good Debt

Income-Producing: The asset purchased with debt generates income helping service the debt. Rental properties generate rent covering portions or all of mortgage costs.

Appreciating Assets: Debt finances assets likely to increase in value over time, building equity that exceeds debt costs.

Tax-Deductible: Interest on good debt is often tax-deductible, reducing true cost of borrowing. Investment property interest (for qualifying properties) is deductible.

Strategic Purpose: Good debt serves clear wealth-building purposes aligned with long-term financial goals.

Examples in Property Investment

Investment Property Mortgages: Borrowing to purchase rental properties that appreciate and generate income represents classic good debt.

Renovation Financing: Debt financing value-adding improvements that increase property values beyond borrowing costs.

Portfolio Expansion: Using equity from existing properties to fund deposits on additional properties compounds wealth through leverage.

Understanding Bad Debt

Bad debt finances depreciating assets, consumption, or lifestyle expenses. It erodes wealth rather than building it.

Characteristics of Bad Debt

Depreciating Assets: Debt finances assets losing value over time. Cars, boats, and consumer goods depreciate rapidly.

No Income Generation: Assets purchased with bad debt generate no income to help service debt.

High Interest Rates: Bad debt typically carries higher rates than good debt – credit cards at 20%+, personal loans at 12-15%.

Consumption-Focused: Bad debt funds lifestyle consumption rather than investment or wealth building.

Examples to Avoid

Credit Card Debt: Carrying credit card balances for lifestyle spending creates high-interest debt funding consumption.

Car Loans for Depreciating Vehicles: Financing vehicles that lose 20-30% of value immediately creates negative equity situations.

Personal Loans for Holidays or Electronics: Borrowing for consumption creates debt obligations without any wealth-building benefit.

Leverage in Property Investment

Leverage – using borrowed money to control larger assets – amplifies both gains and losses in property investment.

How Leverage Works

With $100,000 cash, you could purchase a $100,000 property outright. Instead, using that $100,000 as a 20% deposit purchases a $500,000 property, controlling 5x the asset value through leverage.

If the property appreciates 5% ($25,000), your $100,000 investment gained $25,000 – a 25% return through leverage multiplying your gains.

The Risk Side

Leverage also amplifies losses. If that $500,000 property declined 5% ($25,000), your $100,000 equity is now only $75,000 – a 25% loss.

High leverage creates vulnerability to market corrections, requiring ongoing cash flow to service debt regardless of market conditions.

Safe Leverage Principles

Maintain Conservative LVRs

Maximum 80% LVR: Never leverage beyond 80% loan-to-value ratios for investment properties. Maintain equity buffers protecting against market fluctuations.

Target 60-70% Average: As portfolios mature, aim for portfolio-wide LVRs of 60-70%, providing substantial equity cushions.

Ensure Debt Serviceability

Conservative Income Assumptions: Use conservative rental income estimates when assessing serviceability, accounting for vacancies and expenses.

Stress Test: Model ability to service debt if interest rates increase 2-3% or rental income decreases 10%.

Income Buffers: Maintain stable employment income or reserves that can sustain debt obligations through challenging periods.

Diversify Across Properties

Avoid Over-Concentration: Don't leverage single properties excessively. Spread debt across multiple properties, reducing exposure to any single property's performance.

Geographic Diversification: Properties in different locations reduce correlated risk if single markets experience difficulties.

Build Emergency Reserves

Maintain Cash Buffers: Keep 6-12 months of debt servicing costs in liquid reserves, protecting against unexpected income disruptions or property expenses.

Access to Additional Credit: Establish revolving credit facilities or offset accounts providing emergency funding if needed.

Monitor Debt-to-Income Ratios

Total Debt Service: Total debt servicing across all mortgages shouldn't exceed 40-50% of gross income for extended periods.

Warning Signs: If debt servicing consistently exceeds 50% of income, you're potentially over-leveraged.

Red Flags: When Debt Becomes Dangerous

Increasing Debt for Consumption

Using property equity to fund lifestyle expenses, holidays, or consumer purchases converts good debt (property investment) into bad debt (consumption).

Inability to Service Debt Without Additional Borrowing

If you're borrowing from credit cards or personal loans to cover property expenses or mortgage payments, you're over-leveraged.

Constant Financial Stress

Good debt shouldn't create constant anxiety. If debt obligations cause perpetual stress, reconsider your leverage levels.

Declining Equity Positions

If property values decline while debt remains constant or increases, your equity position deteriorates. Multiple properties with negative equity indicate dangerous over-leverage.

Strategic Debt Management

Regular Portfolio Reviews

Annually assess total debt levels, loan-to-value ratios across portfolio, debt servicing as percentage of income, and equity growth rates.

Debt Reduction Strategies

As portfolios mature and cash flow improves, strategically reduce debt on selected properties. This improves overall portfolio resilience and reduces risk exposure.

Avoid Lifestyle Inflation

As income increases, resist upgrading lifestyle proportionally. Instead, use income growth to improve debt serviceability margins or accelerate portfolio growth.

Plan for Rate Increases

Interest rates fluctuate. When rates are low, model how rate increases affect affordability. Ensure you can sustain higher rates without distress.

The Luminate Financial Group Perspective

At Luminate Financial Group, we emphasize that leverage is property investment's most powerful wealth-building tool when used appropriately. The investors who build substantial wealth through property almost universally use leverage strategically.

However, leverage requires respect. Over-leveraging causes more property investment failures than almost any other factor. The right leverage level is the amount you can comfortably sustain through complete market cycles, not the maximum banks will lend.

Good debt funds appreciating, income-producing assets that build long-term wealth. Bad debt funds consumption or depreciating assets that erode financial position. Keep these categories completely separate – never convert good debt to bad debt by extracting property equity for consumption.

Use debt strategically, maintain conservative LVRs, ensure robust serviceability, and build emergency reserves. These practices enable leveraging property safely for wealth creation while managing risks appropriately.

The goal isn't maximizing leverage – it's optimizing leverage at levels supporting growth while maintaining sustainability through market cycles. Strategic, safe leverage distinguishes successful long-term property investors from those who overextend and face problems during inevitable challenging periods.

Frequently Asked Questions

What's the difference between good debt and bad debt in simple terms?

Good debt finances assets that increase in value and/or generate income exceeding debt costs—investment properties appreciating while generating rental income covering mortgage payments, creating wealth through leverage. Bad debt finances assets that decrease in value or consumption providing no financial return—credit cards funding holidays, car loans for depreciating vehicles, personal loans for electronics. Key distinction: good debt builds net worth over time while bad debt erodes it. Investment property mortgage at 6% on appreciating asset generating 5% yield plus 4% annual appreciation creates positive returns. Credit card at 20% funding consumption creates pure cost with no offsetting benefit. Property investors successfully use good debt strategically while completely avoiding bad debt. Never convert good debt to bad debt by extracting property equity for consumption—this transforms wealth-building leverage into wealth-destroying obligation. Focus good debt exclusively on income-producing appreciating assets creating long-term wealth rather than short-term lifestyle funding.

How much leverage is safe for property investment?

Safe leverage varies by personal circumstances but follows consistent principles. Maximum 80% LVR (loan-to-value ratio) per investment property providing 20% equity buffer against market fluctuations. Target 60-70% average LVR across entire portfolio once established—lower portfolio LVR provides greater resilience during market corrections. Debt servicing test: total mortgage payments across all properties shouldn't exceed 40-50% of gross income consistently. Stress test: model ability to service debt at 2-3% higher interest rates—if you can't sustain rates 2% above current, you're over-leveraged. Income coverage: rental income should cover at least 70-80% of investment property expenses including mortgage, rates, insurance, maintenance (though negative gearing is common initially). Emergency reserves: maintain 6-12 months debt servicing in liquid funds. Geographic diversification: avoid excessive concentration in single property or market. These guidelines enable wealth building through leverage while preventing over-extension causing forced sales during market downturns. Conservative leverage sustained through complete market cycles beats aggressive leverage requiring distress sales.

Can I use equity from my home to buy investment property?

Yes—accessing home equity for investment property deposits is common wealth-building strategy, but requires careful management. Process: your home appreciates and/or you pay down mortgage building equity (property value minus debt). Refinance or establish separate loan accessing this equity while maintaining 80% maximum LVR on family home. Use accessed equity as deposit for investment property. Result: you own both family home and investment property with leverage across both. Benefits: enables investment property purchase without saving separate cash deposit, home equity grows passively creating investment capital, and investment property debt is tax-deductible while home loan isn't (for interest deductibility). Risks: increases total debt across both properties creating higher repayment obligations, cross-collateralization may limit future flexibility, and both properties secure total debt creating risk concentration. Safe approach: maintain combined LVR below 75% across both properties, ensure total debt servicing remains under 40-50% of income, build emergency reserves covering 6-12 months expenses, and stress-test serviceability at higher interest rates. Never access equity for consumption—only for income-producing investment assets.

What are the warning signs that I'm over-leveraged?

Critical over-leverage warning signs requiring immediate action: using credit cards or personal loans to cover property expenses or mortgage payments indicates insufficient cash flow, constant financial stress and anxiety about debt obligations suggests unsustainable leverage, inability to handle unexpected expenses ($5,000-$10,000 property maintenance) without additional borrowing, debt servicing consistently exceeding 50% of gross income leaving inadequate living funds, missing mortgage payments or being late with repayments, and declining equity positions as property values fall while debt remains constant. Additional concerns: no emergency reserves for vacancies or repairs, relying on rent increases or appreciation to make properties work financially, inability to sustain 2-3% interest rate increases, multiple properties with negative equity, and feeling forced to sell properties to manage cash flow. If experiencing multiple warning signs, take action: halt new property purchases immediately, sell underperforming properties reducing total debt, increase income through employment changes or additional work, reduce personal expenses aggressively freeing cash for debt service, and refinance to better structures if possible. Prevention beats cure—maintain conservative leverage from start avoiding over-extension requiring distress management.

Should I pay off investment property debt or my home loan first?

Financially optimal strategy typically prioritizes home loan repayment over investment property debt due to tax treatment differences. Home loan interest isn't tax-deductible making each payment pure cost, while investment property interest is tax-deductible (for qualifying properties) reducing effective interest cost. Example: 6% investment property interest with 33% tax rate costs effective 4% after tax deduction, while 6% home loan costs full 6% with no deduction. Strategy: pay home loan minimums plus extra payments reducing non-deductible debt quickly, pay investment property minimums only maintaining deductible debt, and once home loan eliminated, redirect payments to investment debt or acquiring additional properties. However, consider personal factors: peace-of-mind value of debt-free home may outweigh tax optimization for some investors, home loan typically larger than individual investment property loans affecting total interest, and investment properties held long-term may eventually pay off naturally through rental income and appreciation. Hybrid approach: aggressively pay home loan to 50-60% LVR eliminating high-risk over-leverage, then balance between home and investment debt reduction, and eventually maintain low home leverage while strategically using investment leverage for wealth building. Consult tax advisor for personal situation optimization.

How do I calculate if my investment property debt is sustainable?

Calculate sustainability using multiple metrics. Debt servicing ratio: (Annual mortgage payments ÷ Annual gross income) should be <40-50% across all properties. Cash flow coverage: (Annual rental income - Annual expenses) ÷ Annual mortgage cost—positive result indicates property pays for itself, negative requires topping up from employment income (common initially). Loan-to-value ratio: (Total debt ÷ Property value) should be <80% per property, <70% portfolio average. Stress testing: recalculate all metrics assuming interest rates 2-3% higher and rental income 10% lower—if sustainable under stress scenarios, current position is robust. Emergency reserves: maintain liquid cash equal to 6-12 months total mortgage payments providing buffer for vacancies, unexpected repairs, or income disruptions. Equity buffer: maintain 20%+ equity per property providing cushion against value declines. Run calculations annually as values, debt, and income change. Use spreadsheet modeling various scenarios. If multiple metrics show strain (high debt servicing, low coverage, high LVR, stress test fails), debt is potentially unsustainable requiring corrective action through debt reduction, property sales, or income increases. Sustainable debt means comfortably handling obligations through market cycles without constant stress or reliance on continued appreciation.

Trent Bradley

Trent Bradley is a New Zealand financial advisor specializing in property-backed finance and investment consulting. With over 26 years of experience running his mortgage broking business, he has helped wholesale investors access high-yield property-backed loan opportunities. For the past 12 years, Trent has led Luminate Finance, a New Zealand finance company dedicated to connecting investors with secure property investment solutions.

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