4 facts about debt that every investor needs to understand
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Conventional Canadian wisdom has it that you should pay down your mortgage as fast as you can. This idea, though popular, is exactly the wrong thing to do when to do it comes to real estate investing. Instead you should actually increase the debt in your home to invest in more cash-flow producing property. Why? Here are 4 facts about debt to understand:
Debt used smartly is good
Sure, there is such a thing as bad debt. Think credit-card debt or debt you’ve taken on to go on vacation this winter. That money isn’t returning to your pockets ever again. But there is good debt, too. Debt tied to a cash-flow-positive asset—real estate, for example—falls under this category because it can ultimately make you wealthy while that trip to Mexico can’t. Remember, debt and financial freedom are not mutually exclusive.
Debt is (still) very cheap
It’s easy to lose sight of this fact given the recent Bank of Canada overnight rate hikes, but don’t forget that interest rates are still historically low. More seasoned investors might remember a time (it wasn’t that long ago) when 12 percent was a good interest rate. In the early to mid ‘80s, interest rates that were north of 20 percent were common. There are really two points here. In addition to providing a point of comparison, it also shows just how high interest rates could go in the future. So in the grand scheme of things, now is still a great time to invest rather than pay off your “good” debt.
Equity in your house is useless but Debt is a powerful tool
If you have already paid off your mortgage, congratulations. But you aren’t really benefiting from that equity, whether it’s a $500,000 downtown condo or a $1.3-million detached home in the 905. As I’ve suggested elsewhere, tap into that equity by refinancing. That will get your equity working for you again. Otherwise, it’s just locked up in your property. A word of caution: I’m not saying you shouldn’t have any equity in your home. There are obvious risks to that. But there is also such a thing as having too much equity. Find the middle ground – and invest.
Debt is how the rich get richer
Hard work, smarts, and a little bit of luck: if you look at virtually any high-net-worth individual, the story of how they got to where they are will include these elements. However, don’t forget a fourth ingredient: debt. When you get right down to it, taking out a mortgage is similar to what the wealthy do to get wealthier. They find other investors who will give them money so they can do something with it to make even more money. Again, with interest rates as low as they are, if you can borrow at a rate of a few per cent and invest it into an asset that is appreciating at a rate much higher than that – you win. It’s this basic principle that the wealthy for the most part inherently understand and the rest of the world just doesn’t get.
***If you enjoyed this blog post, check out the podcast episode that this was inspired by here.***