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How debt can make you money

Most people believe that 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.

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 3 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, ten years from when you initially took out your mortgage (assuming the government’s floated inflation level of 3% 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 have often seen inflation tracking much higher than 3 per cent and in some instances according to economists, its been as high as 5 per cent in most recent times.

From this perspective, debt is not necessarily evil. In fact long term debt can be downright profitable if you use it the right way – to purchase income producing property which increases over time, even as your mortgage shrinks through the miracle of inflation.

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About

Rolf is Director of Metropole Finance and has twice been voted Australia's leading finance broker. He shares his wealth of knowledge about how to best use property finance to fund investments.
Visit Metropole Finance


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