Most people believe ‘debt’ is a dirty word. It’s something to be avoided at all costs or, if it’s necessary for some reason such as buying a home, to be paid down as quickly as possible.
BY ROLF SCHAEFER
But what if having debt meant you actually made more money? What if you could be paid to borrow from the banks? Well, you can – and I’m going to tell you how it works.
Many Australians are starting to realise what seasoned property investors already know – income-producing real estate is one of the best ways to generate long-term wealth.
Truly savvy investors also realise that the combined effects of inflation and the income generated by investment properties actually allows you to get paid to borrow money.
Essentially, inflation means that the value of a dollar diminishes over time. However, you can protect yourself against the dollar’s declining value by investing in high quality, long-term debt associated with an income-producing property.
Let me explain using an example. Assume you bought a property in 1980 and at the time the dollar was actually worth its full value – $1.00. However 30 years later, that same dollar is now only worth $0.40 due to inflation, meaning the purchasing power of that dollar has decreased.
While the dollar’s value has gone down though, the principal balance on your long-term property investment debt is not adjusted in line with inflation at any point.
In other words, by paying down your debt with increasingly cheaper dollars than those you originally borrowed you end up saving yourself a substantial amount of money each year.
Let’s dig a bit deeper though and assume you buy an income-producing property worth $1 million with a mortgage of $800,000 that requires interest-only repayments.
After the first year, if inflation was sitting at an average level of three per cent, your loan balance of $800,000 is suddenly only worth $776,000 in real dollars. In effect, this means you just got paid $24,000 thanks to inflation.
Taking this scenario further, 10 years from when you initially took out your mortgage – assuming the government’s floated inflation level of three per cent is applied every year during that period – your $800,000 loan would only be worth $590,000.
If you think that’s impressive, keep in mind that we’ve often seen inflation tracking much higher than three per cent and in some instances, according to economists, its been as high as five per cent in most recent times.
From this perspective, debt is not a necessarily evil. In fact, long-term debt can be downright profitable if you use it the right way – to purchase income-producing property that increases over time, even as your mortgage shrinks through the miracle of inflation.
Rolf Schaefer has a wealth of knowledge about property investment, property finance and complex structures. His ‘can do’ approach has helped many property investors through the finance maze. Rolf has rated among the top Australian Mortgage Brokers for the past five years. For more information about Rolf visit www.metropolefinance.com.au.
That’s what I’m talkin’ about Rolf. The fundamental difference between ‘good’ and ‘bad’ debt. This is ‘good’ debt and one of the many benefits of investing in (well researched) bricks and mortar.
Well written article.
Cheers
Garry
Comment by Garry Macdonald — September 21, 2011 @ 7:45 am
Mr Schaefer – Correct me if I’m wrong, but it seems like you’re slightly insulting all of your astute readers.
If I take out a loan for $800k on interest only, the principle owing is still going to be exactly $800k in 1,2,5…10 years time regardless of inflation – the actual balance will still show there is $800k owing. Correct?
You are ASSUMING that the income being used to service the loan will keep track with inflation, thereby ‘shrinking’ the relative size of the loan principle. But this is NOT the case. There is no rule or law to say that a rise in inflation must equal a rise in rent/or wages.
It is entirely possible for inflation to occur without any automatic rise in wages or rental income. This is actually happening right now in the economy as we speak where inflation is ‘cost push’ – i.e. the cost of essential goods is rising enormously, but without any rise in incomes. In fact, people are losing their jobs and businesses are making less and less money as the economy struggles. This is causing commercial rents to drop and many people haven’t seen a pay rise for 3 years.
So in the case of the current economy, inflation is occurring but people are in fact relatively poorer due to incomes/rents not rising. Or what if the unimaginable happened and the property became vacant, or the investor lost their job? How many years does that put them back, with respect to your ‘ideal’ plan?
How does this stack up against your article? Please correct me where I am wrong, as I would love to see it your way – and wouldn’t we all – but unfortunately it’s not as simple and fool-proof as you make out.
Comment by Dave Robertson — September 22, 2011 @ 7:09 pm
Dear Mr. Robertson,
thank you very much for your detailed response. In many areas I would agree with but of course there are always two sides to the coin.
I am a long standing property investor (20+ years) and the principles that I speak about in my Blog are not just based on inflation adjusted wages but of course to a large extent on increasing asset prices due to inflation and of course demand.
You are absolutely correct when you say that the initial loan (in your example) of $800K interest only will still be $800K in 10, 15 or 20 years. But what will the asset be worth securing this loan?
I am happy to sit down for a coffee with you should you wish to discuss this further.
PS: All my employees had pay rises in the last 10 years -:)
Comment by Rolf Schaefer — September 23, 2011 @ 4:53 pm