Full video transcript below:
I’m Nick Aves from Purely Finance. We’re mortgage brokers and I’m a licensed credit adviser. We specialise in helping investors of all levels, from people just looking to get in the investing market right up to people that are very experienced investors doing very large developments.
Today, I just want to start talking a little bit just about the money fundamentals of how money works, why you borrow money to invest and the different types of loans you can have because if you speak to somebody like my father from his generation, all debt is terrible; all debt should to be paid off straight away.
So, I talk about debt in three ways and the types of debt I talk about, the first type I categorise as “bad” debt or bad loans; and then I talk about “good” loans; and then I talk about “excellent” loans. And what do I mean about that is by understanding these three types of loans and getting them right in your head, it will help you with the way you structure your finances.
So the first type of loan that we talk about when we are talking to our clients, that’s a bad loan, is any type of consumer loan—so anything for an asset that doesn’t go up in value. So we’ve all heard the story where you buy a brand new motor car, you take it around the block, you bring it back to the dealer and you say, ”You know what, I made a mistake. I’d like to trade this car back in.” Well guess what, they’re gonna give you a fair bit less than what you have just paid a few hours beforehand. So the asset is going down in value. The other thing is that the money that you borrow to buy these assets can often be quite high—so, higher than a home loan, higher than an investment loan. So with bad debt, which is consumer debt, when we are looking at clients in structure, and then we say that’s the debt we wanna pay down first; we wanna knock that debt off as quickly as we can.
I am not suggesting that you can go and buy a car for cash—that’s unrealistic. So people do need to borrow money but we wanna do is to borrow the money responsibly and we wanna have the ability to pay that down. It can be some exceptions for people that are self employed and are buying a work vehicle because that can then be a tax deductible debt. But generally, we wanna get these loans down. So things like credit card debt, Harvey Norman is a classic interest free [example]; if you go past the interest free period, it becomes very expensive. So we wanna make sure that we just got that under control.
Now, for anybody that’s bought a house in the past, I’m sure you’ll agree that it makes sense to borrow money to go and buy your home. Because if you are trying to save the money, as fast as you save, but it appears that the house tends to keep going up over time and you can never get to a situation where you can actually pay cash for a house. And certainly that anybody that’s bought a house some time back will now have equity in that property. So it does make sense to borrow money in my book, to borrow money to buy a home.
But excellent debt— and this is the side that my father can’t get his head around—can be money that you borrow for investing. And I say it’s excellent debt because basically what you’re doing is you’re using somebody else’s money, normally a lender, to try and invest that money to get a better return than what the money is costing you. So using somebody else’s money to try and get ahead financially. The interesting thing is and I should have mentioned earlier this is just very general advice, so obviously you need to get a specific advice for your own situation.
But generally, if you have a home loan today and it will be a very small home loan. But let’s say you only have a home loan of $200 000, which is quite a small home loan. The thing that is staggering is that you could easily borrow $1 million for investing and the cost to you for those borrowings are very similar. And as far as that’s the thing that are always…people say to me. They say, “You know, look, we’ve got some friends: they are in a similar situation to us and they got a similar sized family and we know we got a similar sized mortgage, yet they’ve got three investment properties. How on earth can they afford three investment properties when we are about in just a hair in our mortgage?”
It’s because investment debt can be so much cheaper to service than a home loan debt. So for example, here with the home loan, the person that is making the payments is you. You get paid, the tax gets taken out of it and the money that’s left you pay all the bills including your mortgage.
Over here, when we are talking about excellent debt, it’s a little bit different. Because if we are talking about investment properties, you’re gonna buy a little investment property. All of a sudden, you got a tenant in there and the tenant is helping to pay this mortgage. So the tenant would pay about 60%. Now, these figures are generalised figures but just to give you the concept. It could be a little more now, because interest rates are historically lower as I recall this in August 2014. But at the moment the tenant is paying a fair bit of the mortgage and it can be more than 60%.
The other thing depending on your situation is that and also the property you buy, but there a tax benefits for buying investment properties. So the tax man is helping you pay some of these debt back. And if we said 20% there, that’s 80%, that leaves you here. And your contribution is example be 20%. 20% of a million is $200 000. So I wanna suggest, sort of a talk about that concept because some people have a concept that all debt is bad and all debt is the same. All debt is not the same, and when we look into structuring your loan and structuring your cash flow, it’s very important; we take that into consideration.
This brings me perhaps to the next thing is: “Why would you borrow to invest?” And that’s really a thing called leverage and I’ll just quickly show you what I mean by leverage.
Leverage is this: if you had a $100 and you invested that $100 for a whole year and let’s say you got 10% on that money, which is quite a high, high figure but it’s a nice round figure. That means at the end of the year you would make $10. OK? And that’s a 10% return. Now if you increase your investment to say $1000 and you have the same rate of return (10%), you’d now be making $100. So it’s the same rate of return but you just got more “skin in the game”; you got more money invested.
And if we increased that, obviously this is gonna just keep going up, 10% as well and now we’ll make a $1 000 and so it goes up. If you have a $100 000 invested at 10%, you got $10 000 and if we have $1 000 000 at 10%, you make a $100 000.
So I think this is a key concept to understanding when you’re borrowing money and you’re looking to increase your leverage because people get scared off from investing because they hear horror stories. And horror stories are often where people getting, start to invest in things they don’t understand, by people that they don’t really know and they can get ripped off.
So what we are not talking about is trying to get a sexy return. We are not talking about trying to double your money or find some magic bullet that’s gonna end all your financial woes. We’re talking about a reasonable return, whatever it is, and we could change the figures to 5% and it wouldn’t really matter and has the same sort of change. But what we’re looking to do is to increase the money you’ve got invested. And we all hear the stories about the rich getting richer, it takes money to make money. But when you’re starting out, slowly but surely, if you get into a situation where you can borrow some money and if that debt is at the level that is…you’ve got the ability to service and you’re not over borrowing, and you’re going to an asset that is being well researched, using some professionals to help you do that, then borrowing a slab of money that you can leverage to get a return will certainly help you on your way.
It works in reverse as well, of course, if the investment goes down 10%, well guess what, if got a $100 and you only lose $10 and if you got a million, you lose $100 000. So it is important that when you’re looking into investing, we’re looking at time frames, we’re looking at trying to minimise your risk by getting some good expert advice to help you along your way.
So, that’s just a little bit about money; just a few key concepts we talk about. And I’ll touch later on about some strategies for developers when they’re looking to borrow money. Thanks so much!
Credits to: Investors Edge Real Estate for the video