|Debt Can Be Your Friend
Today there’s a lot of talk about eliminating debt. What is the biggest debt most of us have? Our mortgage of course. Most homeowners believe the most successful strategy to financial security is to eliminate the debt of their mortgage as quickly as possible. Many do this by sending extra payments to their lender to lower interest fees and reduce the principal. This makes sense if you operate under the assumption that debt is your enemy to be eliminated as quickly as possible. But what if we viewed debt as our friend?
Some debt, when managed wisely can be very desirable. Let’s look at debt. If you think about it you can only do four things with your money. You can spend it (I’m good at that one), give it away, lend it or own with it. When we put our money in a savings account we are putting it in a “lended position.” The bank pays us an interest rate for loaning it that money. A bond or another kind of debt instrument works in the same way.
When banks borrow your money by allowing you to open an account with them they are placing themselves in your “debt.” This is not to say they are being unwise. On the contrary, they understand the difference between good debt and bad debt. They rely on the proper management of debt in order to make a profit for themselves and their stockholders.
Equity Fails the Three Tests of Wise Financial Investing
On the other hand, if we put our money in an equity or ownership position we incur greater investment risks but we also position ourselves to capture greater appreciation on that equity. This happens when we purchase stock or real estate. The downside to having too much of our assets tied-up in real estate equity is that our money is not liquid, yields no rate of return, and it is not safe. We can, however, accomplish both goals by using debt and equity to balance our assets so that we meet the three tests of wise financial investing:
1 – Lacking Liquidity
Money tied-up in real estate equity does not pass the liquidity test because even though it’s YOUR money and you paid it to the mortgage company, THEY get to decide IF they will loan some back to you, how much you deserve and what interest you should pay them for the privilege of using your own money! Having too much equity invested in our properties make us house-rich and cash poor.
2 – Yields No Rate of Return
One of the greatest misconceptions that homeowners operate under today is that the equity in their home is generating a rate of return. Nothing could be further form the truth. While real estate DOES appreciate and this has the potential of creating a return on investment, it appreciates at the same rate regardless of whether it is mortgaged to the hilt or owned free and clear. A higher equity position does not make the property more attractive. In fact, a lower equity position can make some properties EASIER to sell.
3 – Unsafe
Finally it is unsafe to have too much equity tied-up in a home be it a primary residence or an income property. The reason for this is that at anytime the mortgage company can decide to call the loan. This does not happen because we continue to pay our monthly or bi-weekly mortgage payments on time. What if something happened like a physical disability or catastrophic event that precluded you from paying your mortgage? Well the mortgage company would foreclose on your home and you would lose every penny of equity with it. Does this like a safe investment? I think not.
These are the strategies which are outlined in the 560 pages of Missed Fortune. Intimidating as that might sound, the book is jammed full of easy to understand and practical money strategies. Andrew himself says, “This book will teach concepts and give insights that are contrary to popular belief. Now is the time to discover the best way to safely accumulate more money.”
I recommend the book to homeowners, investors, realtors and everyone interested in acquiring more wealth.
By using equity and debt wisely we can increase our ability to leverage our assets so that they are producing a significant return on investment. In this way we can make the best use of knowledge and practice street-smart financial strategies that help us to “make our own luck.”