Mutual Funds Awareness 106: Debt is a double-edged sword.
Debt refers to borrowing money from a person or a financial institution, with the promise of repaying it. A much more common name for debt would be “loan,” and the period of repayment could be from 1 day to over 20 years, depending on the terms and conditions you have agreed to.
When I was very young, my dad told me to avoid debt. Do not take loans or lend money to your friends, because if they did not pay back then they would no longer be your friends.
What about you? Do you get worried by the thought that you owe money to someone? Getting sleepless nights because your repayment dates are nearing and you do not have a sufficient balance in your account? Would you feel insecure if the loan collection agents show up at your residence in front of your family?
This is the dark side of debt, one that 99% of people are familiar with. I am here to discuss the positive aspects of debt, which is being utilized by 1% of people, and these individuals are among the wealthiest around.
The reason 99% of people have seen the dark side of debt is that they have used it to buy a liability and not an asset. Not just that, the collateral they have kept would most likely be an asset. In case you are not able to repay the loan, you will lose not only “the loaned item” but also the asset.
When you buy a car using a loan, it is hypothecated in the bank’s name. The car is not an asset because it does not generate revenue for you. In fact, the car loses value every year, proving it’s just a liability. If you had taken a loan for 7 years, and paid diligently for 4 years, but defaulted in the 5th year, the bank will still seize your vehicle. If they are unable to recover their costs, they will ask you to pay out of your pocket. In case you pass away, that debt goes to your family, and they will be troubled for it.
Similarly, when you take a home loan to buy a house and end up staying in it, it’s still a liability. The reason is that the house is not generating income for you. Agreed, that you are saving on some other rentals that you would have paid if you didn’t have the house, but it’s still not an income.
Want another proof that it’s not an asset? Tell me, how do you intend to repay the EMIs? Most likely, the EMIs are paid from your salary or primary income, rather than from the rentals you receive. If you are fired from your job or you become incapacitated, the likelihood of the loan defaulting goes up.
Just like this, calculate every loan that you have taken, it’s to buy a liability that would have been falsely marketed as an asset to you. If that scared you, good, because you are about to learn how to use debt to buy assets and save taxes. Keep reading.
Loans should be used to buy assets, and no one else understands it better than corporations. The image below is the annual profit and loss of TATA STEEL for the last 11 years. The row highlighted in red is their annual interest outgo amount.
In 2025, they made an interest payment of 7341 crores. If you analyze their balance sheet, you can quickly find that their borrowings were 94801 crores that year. In layman’s terms, that means they had taken a loan worth 95000 crores, and they have to pay ~7300 crores every year as interest alone.
This is the good debt I am talking about, because the company had a net profit of 3174 crore that year, after paying back all its liabilities. Which means they repaid the interest, paid taxes, and still had profits to distribute.
The primary reason they are using debt is to build assets. They might take out a loan to buy machinery, and they immediately put it to good use, generating money through it. The secondary reason is that they receive tax breaks when they take on debt. The entire interest payment is tax-deductible.
Let’s come back to your case. If you take out a loan to buy a car and then use it as a taxi, it becomes an asset. The annual interest you pay for the loan is tax-deductible. You pay lower taxes if you have debt.
Similarly, if you take out a loan to buy a house and rent it out, it becomes an asset. The rentals should ideally cover your EMIs (but that wouldn’t be the case in India, that’s a separate story for another day) + the interest component is tax-deductible.
Were you aware?
Note: Buying a car using a loan and attaching it to a taxi fleet service is a better idea than buying a property, as the fares from the taxi service will offset the EMIs. Properties in India are damn overvalued, and the rentals are damn cheap. There is no way you can recover the EMIs from standard rentals.
The super-rich 1% of the population use debt even in their personal life. This saves them a ton in taxes.
Let me illustrate with an example.
If Ramesh has a mutual fund holding worth 10 crores and wishes to buy a house for two crores (to let out), the popular choice would be to redeem two crores worth of MFs and use that fund to buy the new property.
Well, that’s a terrible idea, because you end up paying 12.5% taxes here. So, if you redeem 2 crores, you will receive 1.75 crores in hand after taxes.
The smarter option is to pledge those mutual funds to get Rs2 crores worth of funds and then buy the new property. If you assume the loan against mutual fund interest rate is 10%, it translates to an interest outgo of 20 lakhs(simple interest) per year.
Once the rentals start coming in, repay the debt and also remember to deduct your final tax computation by 20 lakhs as you had borrowed money to fund your rental business.
Note: The actual interest component would be lower, but for simplicity of calculation, I have taken a flat 10% per year calculation. To qualify for a tax break, you must report it as business income; it is not necessary to have a private limited company at all times.
You gain two advantages when you fund your asset purchase through loans.
- Your existing assets are not liquidated and taxed.
- Whatever interest you incur on the loan is tax-deductible from your total annual income.
Since you are not using the assets to meet your personal needs, you would not feel bad if you had to dispose of them in case of a financial emergency. You can always sell off the extra house if you are unable to repay the debt. The personal attachment comes to those things that you use for yourself. You wouldn’t really mind if the loan agent repossessed one of your taxi fleet, but if he takes away your primary car, it’s a disgrace.
If you have never thought about it, take a minute or two to comprehend how much money you are going to save. All the rich people are already using this method. Next time you apply for a loan, consider whether it’s to purchase a liability or an asset, and then think about this idea.
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