If you have a mortgage, and the value of your home is higher than your home loan, you have equity. With equity comes options, and you can use this equity to create wealth. Ever heard the saying the rich get richer? This is the way they do it. They take their equity and using other people’s money, usually the banks profit, they borrow to buy more and this produces more equity. They are on the ever-increasing wheel of wealth.
Unfortunately, most people are on the other wheel, the ever-increasing wheel of debt. If you have a mortgage and some personal or ‘consumer’ debts like credit cards, personal loans or car loans it is amazing how quickly you can become overwhelmed with payments. It seems like all your income is committed to repayments and basic living expenses like groceries, leaving little or no money to pay other essentials like insurances, car rego, school expenses and electricity. It seems you need to either go without luxuries like holidays, Christmas and upgrading furniture or, worse still, you need to go on ‘interest free’ or credit cards which add to the burden and the whole cycle starts again.
Money just doesn’t have to be that stressful. It is amazing when you actually look at how to do your banking properly and more importantly how to manage your income or cash flow, just how quickly you can regain control.
The problem with saving and investing just in money is that money devalues over time! Let’s say you retire with cash invested, say $500,000 and you get 10% on the cash investment (which is probably not likely). This is going to give you $50,000 per annum. We are taught that we should be living off the interest.
However, when you start to live off the interest, guess what happens? The cost of living goes up. So, if you spend more than $50,000 per annum, you will start to eat into the capital and then with less capital you earn less interest. This will happen year after year, until unfortunately, you run out of money. That's what happens when you invest in cash, and that’s why I say, cash doesn't work.
So, if that money devalues over time you’ll have less to spend. That’s why you use money (equity) to create more money and build a property portfolio. The reason property works so well is the ability to borrow money to accelerate the accumulation of wealth.
If you had $100k and invested it (at say 10% p.a.) in 10 years you would have $260k. If you had $100k and borrowed money to buy a $500k property (with a $400k debt) and property increased by 10% p.a. for 10 years, you would have $1.3 million property, less the $400k debt = $900k. While there is no guarantee that the returns are on the cash investment or the property, this simple example merely shows that using OPM (other people’s money, i.e. the banks) can accelerate wealth creation.
For this reason, at Think Money we use money – or equity – in a property, to create more money by building a property portfolio. As time goes on, the value of the property goes up and so does the rent and over time turns positively geared and that's where your income is going to come from in retirement. So, as well as money devaluing over time, debt devalues over time, which is really important. So, the positively geared income can actually pay off your mortgage faster.
You're then going to have excess money (equity) that can be reinvested back into the property market. It can offset the negatively geared properties as your building your portfolio but in the end it will decrease the debt as well.
When it starts, properties are negatively geared. So, if you've got the perfect property, it should start negatively geared. A big mistake people make is to think ‘oh we need a lot of income to hold the property’, so therefore let's go positively geared. But when you pick properties that are high in income, they're high in risk and high incomes usually don't last all of the time. They come into favour, out of favour, back into favour, out of favour, so there's a lot of volatility. However, when you buy normal, conservative properties in standard areas with the normal growth patterns, this is what happens. As time goes on, the value of the property goes up and so does the rent and it eventually over time turns positively geared and that's where your income is going to come from in retirement. But we're going to take time to get to retirement so we're going to utilise that money in the meantime.
Now if you hold property long term, the value's going to go up, the rent's going to go up and eventually, you're actually going to be living from the retirement side. However, until you retire, it's accumulating money and paying off debt without any effort from you. This is what I call ‘NPI’, non-perspiration income. When you retire, it’s your money to live on.
So, don’t be afraid of debt. And don’t be afraid of using equity. It’s these fears that hold us back and why some people retire poor because they don’t learn how to do it correctly.
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