Maximizing Gains: Harnessing the Power of Debt

  • Maximizing Gains: Harnessing the Power of Debt

Debt has always been a scary word in Australia. But that could be because most Aussies are going about it the wrong way.

They get into debt on their credit cards, or over-borrow on owner-occupier ‘dream homes’ or renovations.

But savvy investors know that debt can be a powerful tool for growing wealth and maximising returns.

First, though, you need to differentiate between good and bad debt.

What’s the difference?

Good debt is debt on an asset that

appreciates in value and has a cashflow coming in that helps service that debt.

The greatest example of this is property.

Bad debt is something that depreciates

in value and you are paying it off yourself, with interest, because it is not

bringing in an income. A car is a perfect example of bad debt, or even worse, a

credit card, where you might end up stuck paying high interest on a material

possession like furniture, or a holiday that you have already had.

So once you have good debt, how do you harness its power?

An investment loan

The most common way that Aussies leverage their debt is through mortgage financing. If you do it the right way, the returns on your debt will far outweigh your borrowing outlay.

You can do this with a family home and pay it off over time while it appreciates in value.

But let’s focus on investment loans, because they allow you to build wealth faster with a smaller outlay, while enjoying the instant reward of rental returns that hopefully mean that after paying a deposit, you don’t have to put any more of your own money into the loan.

Say you buy a property for $200,000, with a 6% interest rate on your loan. That’s around $12,000 a year that it will cost you to hold that debt. But if you rent it out for $400 a week, you have $20,800 a year coming in. After holding costs, the remainder goes into your pocket as extra income.

Using equity and boosting appreciation

Being able to capitalise on property value appreciation is one of the greatest advantages of leveraging debt.

As the value of your investment properties increases over time, your return on investment is the total property value, not just on the initial capital invested (your deposit).

So if you put down a 10% deposit on a $200,000 property and the property doubles in value, the whole extra $200,000 is yours. Not bad for a $20,000 outlay.

While you won’t realise your whole gain unless you sell the property, you can use it along the way for further investment. Useable equity refers to the portion of the wealth you have accumulated that your lender will allow you to use as a deposit on your next property.

So if your property doubles in value, you will have enough useable equity to be able to put a deposit on another positively geared investment property and then use rental returns to service that next loan. Your first deposit has essentially served as a means to keep investing.

Give yourself a payrise

Another benefit of using debt for multiple investment properties is that rents will increase over time thanks to inflation. Your debt of course stays the same and eventually diminishes.

So you are creating different income streams that are attached to inflation and can help sustain you later in life.

One day, the $400 rent on your $200,000 property will become $1000 a week. When you eventually pay off the properties in your portfolio, you will be left with a portfolio of assets that are paying you money and you don’t need to use it on any more loans.

Which brings us to your exit strategy

Most investors pay interest only on their loans in the initial stages, so they can make sure they are positively geared. But it’s still important to pay down the debt at some stage so you can be unencumbered.

Some people will pay interest only until rents have risen enough to cover the principal too and then they transition to begin paying down the debt. Others might sell off one or two of their assets in order to pay down the debt on the rest.

 

 

Take the first step to financial freedom and contact us today

Our team is ready to take you through every step of a successful property investment journey.