The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: Dicey on April 22, 2012, 12:46:24 AM
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When my company scrapped the company car program, I bought my old company car and wrote a check. My credit union is now offering used car loans for 1.99%. I'm debating whether I should borrow against my paid-for car at that low rate. I have two mortgages (two houses), 18 month EF, 401K, Roth and no other debt. I use my CC's sparingly and pay off every month. Hard to imagine any other scenario that would include installment-type debt. I'm thinking of borrowing say, 3K, parking it at same credit union and auto-paying it off in 12 months. Would it make much difference on my credit report? Seems like it could be worth it for better credit scores, which are currently high sevens/low eights. Any thoughts? Can't really think of any other way to boost my scores.
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Why would you want to pay interest? And I doubt that the CU would give you a loan for a car that you already own and have paid for. You already have 2 mortgages - that's enough to tell the credit bureaus that you can handle installment debt responsibly. The best thing to do, in my opinion, is to simply pay your bills on time. Timely payment is around 30% of your credit score. With a score close to 800, I doubt it would make any difference in the interest rate you would be offered. I suggest you read Liz Pulliam Weston's "Your Credit Score" for more information.
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I would "want" to pay interest *only* to boost my credit score. A car loan is a different type of loan than a mortgage or credit cards. Sorry if I was unclear: I AM pre-approved at my Credit Union to borrow against my own car, in exchange for the pink slip. The loan as outlined would cost around $60.
For comparison, note that the majority of 0% credit card balance transfer promotions carry a 3% "fine print" up-front processing fee, though few seem to recognize that as interest and I don't have any balances to transfer anyway.
So another way to ask my question is: "Would this be a cost-effective way to improve my credit score and would it work?" I am in my early fifties and have been paying bills in a timely manner all my life. I feel I have reached a ceiling of sorts. Is this a way to break through it? This is not a Finance 101 question, which is why I'm seeking advice from the pool of Black Belt Moustachians here.
PS- I have been reading LPW since her early LA Times days, before blogging existed. Yeah, I'm that old and so is she.
PPS - Any financial institution will lend money against a pink slip, as long as the vehicle's value is more than the loan amount, at a rate determined in part by the borrower's creditworthiness. Finance 101.
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I took out a small car loan to boost my credit rating and auto-paid it out of a savings account. My credit history was *empty*. If your credit scores are already in the high 700s/low 800s and you already have two mortgages, I don't see how taking out a car loan would help you. It would just cost you the interest.
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You can earn at least 0.84% interest in an online savings account from Ally, which will offset some of the loan cost. Also, the loan would not cost $60 anyway, unless that includes some up front fees. You won't be paying interest on the full $3000 for the full year. The actual interest cost would be about $32.44 before you even consider the small income you get by putting the $3000 in savings. If you have no other non-mortgage installment loans on your credit history, I would do it. I would look at it as a gamble. There is a chance you spend less than $30 and get no benefit. There is a chance it increases your score and you save much more than $30 on your next mortgage or other loan. That is a risk I'd be happy to take. Of course, if you don't intend to borrow money for anything else in the next several years, there really isn't any upside to having a higher credit score.
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Does high seven low eight mean high seven hundreds low eight hundreds? If so, what is wrong with that? Is there some contest to have the highest credit score?
Seems to me credit scores matter the most to people who have low scores and have to make small payments. They get reamed by high interest on loans they cannot pay off quickly.
If you get a car loan, all you do is add to a utilization ratio which might actually lower a score. If you pay your bills on time, to increase your credit score you might need a line of credit or more credit cards with high limits you never use to decrease your utilization ratio
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DB - Thanks for the Black-Belt answer. I agree that there isn't a large amount of upside, but the best time to improve your credit score is when you don't need credit, no? Maximizing my score enhances my sense of financial well-being and optimism. Sure, it would be great if I never needed to borrow money again, but that's unrealistic. In a way, it's like purchasing insurance against a possible future need. Should I find myself in a position of needing cash, I can be assured of not paying through the nose to get it. Thank you for helping me think it through. I'll make a decision this week and post the results.
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WTF is peoples obsession with their credit score - why do you care? Are you planning to take out a major loan in the next three years, is your current one rubbish?
If not, put this "manipulating my credit score crap" in the wooden chest at the back of you mind close the padlock and throw away the key.
The best thing you can do is pay down you current debts, not take on more.
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Maximizing my score enhances my sense of financial well-being and optimism.
FFS. Find something else to boost your financial well being - like saving money for financial independence.
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WTF is peoples obsession with their credit score - why do you care? Are you planning to take out a major loan in the next three years, is your current one rubbish?
Because of the thousands of dollars it can save you or make you.
Small example: Right now lots of people are complaining about trying to get loans for housing, that the credit markets are tight. Despite that, of the 5 houses I've purchased in the last few years, I've got loans on three of them due to my excellent credit scores. (The other two were purchased with cash.) Just like cash gives you opportunities, so does good credit, by giving you access to leverage and other people's money. It's not for everyone, but it can be advantageous if you are smart about it.
I don't "obsess" about it. In fact, I've never done anything to actively say "this will boost my credit score" that I wasn't doing otherwise. However I wouldn't do something that would hurt my score, because I actively use it to make me money.
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Hi Gooki - Before you take such a sharp tone - which you're perfectly entitled to do - consider reading the question thoroughly. I posted this question hoping for thought-provoking responses from some MM heavy hitters. DB and arebelspy made me think and were helpful. Yours missed the mark completely, but thanks for trying.
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My understanding is that a score of 850 doesn't get you much more than a score of 750 does. I would pay more attention to what you can do with a free $3K. If your tax-adjusted mortgage interest rates are higher than 1.99%, then take out the car loan and put the $3K into a mortgage. Pay the $3K back over the longest possible term so you can keep focusing on the more expensive debt.
http://badmoneyadvice.com/2010/03/the-truth-about-mortgages.html
I just borrowed $8K at 2.5% to buy a car. Because I didn't sink that $8K into the car, I have money to pay down more expensive school debt, or even my 3.75% mortgage. When I finish paying off the higher-interest debt, I'll pay off the car loan.
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Where ever I see something that screams addiction I get on my tough love horse. And for me it seemed you were addicted to debt/your credit score.
Can you provide one scenario where your current credit rating is insufficient?
And as others have mentioned, just parking the money in a cash account is foolish when you have higher interest debts. And the effect of borrowing $3k is likely to have zero effect on your credit score when you have much larger debts that still require servicing.
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My understanding is that a score of 850 doesn't get you much more than a score of 750 does. I would pay more attention to what you can do with a free $3K.
This. If your score is already in the high 700s, it won't pay anything to make it better - you already qualify for the best rate tier. However, there may be advantages to borrowing at a low rate and investing at a higher one. To answer your original question: yes, it will help your score if you currently have no non-mortgage installment loans on your CB. Types of credit is an important factor. No one will be able to tell you exactly how much it will help, though.
And I doubt that the CU would give you a loan for a car that you already own and have paid for.
It is not uncommon to loan money against a paid-for car. If you think about it, why would it be any different than a regular purchase or refinance as long as the collateral is acceptable to the lender and the borrower qualifies?
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It is not uncommon to loan money against a paid-for car. If you think about it, why would it be any different than a regular purchase or refinance as long as the collateral is acceptable to the lender and the borrower qualifies?
Search Google for "vehicle equity loan," and you'll get a bunch of payday-type loan sites. I'm guessing people generally don't borrow against their car unless they're in trouble.
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I just borrowed $8K at 2.5% to buy a car. Because I didn't sink that $8K into the car, I have money to pay down more expensive school debt, or even my 3.75% mortgage. When I finish paying off the higher-interest debt, I'll pay off the car loan.
I have done this a number of times with our student loan debt (very close to having all our debt under 3.875%). In this economic climate I'm all for borrowing cheap money to pay off expensive money when the opportunity arises. This sounds like one of those opportunities.
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It is not uncommon to loan money against a paid-for car. If you think about it, why would it be any different than a regular purchase or refinance as long as the collateral is acceptable to the lender and the borrower qualifies?
Search Google for "vehicle equity loan," and you'll get a bunch of payday-type loan sites. I'm guessing people generally don't borrow against their car unless they're in trouble.
That is probably true, but most people don't know they can borrow against their car at a regular bank. Then again, most people with cars that would qualify probably already have a loan on it from its purchase. The type of folks I know that pay off their car loans early are the same folks that wouldn't actively go looking for money to borrow.
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Okay Gooki, just for fun, I'll give you a little more background, mostly because your comments amuse me. While you're whiffing balls, a number of others have made comments that are quite helpful.
My brother and I had a conversation recently about credit scores. I have no particular interest in them, except as it applies to mortgage debt. As mortgage rates change over the years, what once was a great rate is no longer. I have lowered my mortgage rate significantly as rates dropped, primarily because of my high credit score, high savings and LACK OF CONSUMER DEBT. I only know my credit scores because I did a re-fi on my house last year to get my rate below 4%.
When my brother showed me his credit scores, I wondered why his were so much higher. The only reason we could figure is that he's been buying cars with loans all the years that I was happily driving a company car. That's where the seed was planted. Then I stopped by my credit union with a deposit check from my new tenant, and they mentioned the 1.99% car loan. Yeah, when you clearly don't need the money, they want to give you lots of it.
I'm a fairly die-hard non-consumerist, so there are not many chances to improve my score. This just seemed like it might present a decent cost-benefit ratio. This is PhD level Moustachianism, which is why I posted my question here.
Yes, I am aware that your house is paid off - many kudos to you, but our situations are different - mortgage payoff is not my immediate goal.
Other than a touch of occasional sibling rivalry, I believe I have my "addictions" under control. I do appreciate your willingness to administer "tough love" but don't see how it's germane to the question.
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Diane,
Credit mix -- or the types of credit used -- accounts for roughly 10% of your credit score. Based on that, the terms of your used car loan, and your intention to pay it back in a year, I think it's worth the risk to effect a modest credit score bump.
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mortgage payoff is not my immediate goal.
If you don;t mind me asking, what is your immediate goal?
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Dear Gooki,
The company car went away is because the job went away. Fortunately, I was given a position in another division and was able to purchase said vehicle (in cash) for a reasonable price. In this economy, who knows what will happen next? My goal is to be prepared for life's curveballs. The time to strengthen your credit rating is when you don't need it. Since I live in an very high COLA, paying off a mortgage is less important to me than a big, fat emergency fund, lots of dough stashed in retirement accounts and excellent credit.
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Keep in mind that not everyone's goals are the same.
Personally, I'm looking to retire once I have 1MM in liabilities.
One path that I may likely take is to NEVER pay off a mortgage, eventually acquire over 20 of them, and refi them to longer terms to take cash out when they get paid down.
Mathematically it's far, far superior to paying them off.
Not everyone is anti-debt.
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In case anyone is wondering, arebelspy is not Dave Ramsey. lol.
But yes, not all debt is evil. Making millions convincing others it is evil might be, though.
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The time to strengthen your credit rating
I don't know that you are strengthening it, and I think several posters have tried to point that out. What could you do with an 820 credit rating that you couldn't do with a 780 credit rating? How are those two any different from each other?
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My brother and I had a conversation recently about credit scores. I have no particular interest in them, except as it applies to mortgage debt. As mortgage rates change over the years, what once was a great rate is no longer. I have lowered my mortgage rate significantly as rates dropped, primarily because of my high credit score, high savings and LACK OF CONSUMER DEBT. I only know my credit scores because I did a re-fi on my house last year to get my rate below 4%.
You've just hit the nail on the head I reckon. Your car loan (I believe) has zero chance of decreasing the rate on debt when you next remortgage. In fact, it may even increase it. There are other factors that are far ahead of credit scores which lenders use when determining whether to give you mortgage debt and the rate to offer - namely rate available to them on the interbank market, their current book and appetite to lend to a particular segment, your LTV ratio, age, location of property, your income and financial commitments which reduce that income (the consumer debt you want to take on).
I think gooki is speaking a lot of sense, but you just don't like it. Why take out debt when you have savings? It might help you get more consumer debt at a decent rate, but why would you want to do that?
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In case anyone is wondering, arebelspy is not Dave Ramsey. lol.
Hah! :D Certainly not.
FWIW, I agree that the car loan may not raise the OP's credit score and that even if it did, it may not be worth it (i.e. the higher score may do nothing for you).
My only point was that credit can be quite beneficial to get you good debt / leverage. Mortgage payoff and being debt free may be some people's goals, but it's not the path everyone heading to FI takes.
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Hi Everyone,
Thanks to all for your thought-provoking feedback.
I did it yesterday. I traded my pink slip for some "invisible" cash. I borrowed 5K for 24 months. Here's my repayment strategy: After 30 days, I will pay back half the loan. I will then pay the balance off over the next twelve months, IF I can stand to wait that long. Payments will be transferred from the savings account automatically. I decided to take more than I originally mentioned because of the decision to pay back half right away. I have a vague idea that this scenario might be more effective if if shows that the loan balance is less than half the total loan amount fairly quickly. I freely admit that this is a hack that may or may not work. I'll wait for about six months to ping my scores. If it has worked, I may just pay it all off then. The only surprise was a $15 DMV fee that the CU said they could not waive. I can live with that. Oh, and with autopayment and all that jazz, the interest rate is 2.19%. Not bad for a used car. I may have gotten a hair less interest elsewhere, but my CU is local. It took 20 minutes from start to finish. Interestingly, they did not pull my credit scores to approve the loan. It was "auto-approved" based on my existing account. Again, thanks to everyone. I've learned quite a bit and will let you know the results.
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Good luck. Thanks for updating us.
Might as well stick it out the full term now that you've gone for it. Whether or not scores are raised in 6 months, who's to say they won't raise if they haven't yet, or won't go higher even if they have gone up? Might as well give it the full experiment now that the ball is rolling, IMO. (And check scores now, at 6 mo., at 1 yr., and 18 mo., after it's been paid off awhile, to see if paying it off raises them or lowers it back down or what).
I'll be interested to hear the results.
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I wrote that post late last night and omitted a confusing detail or two: Once I decided to take a higher amount and then pay off half, I had to opt for a 24-month term for this to end up being a 12-month loan. The monthly payment is fixed, so if I paid off half of a 12-month loan, there would only be six payments left. With the method outlined, the whole thing will be paid off in 12 months. I haven't the stomach for anything longer. There is a cost/benefit ratio here and I don't want to exceed it or my comfort level by dragging things out.
I like your idea of checking at regular intervals. Any thoughts on how to obtain my credit scores cheaply along the way? I am not score-obsessed and only know what they were when I re-fied last December.
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You can get a free credit report up to once every year from each of the three credit rating agencies: Experian, Equifax, and TransUnion. Just get one from one of the agencies now, then another in six months, and another in 12 months.
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You can get a free credit report up to once every year from each of the three credit rating agencies: Experian, Equifax, and TransUnion. Just get one from one of the agencies now, then another in six months, and another in 12 months.
Those give you a credit report, but not a score. That won't help the OP trying to tell if her score went up or by how much.
You can subscribe to a yearly service for 10-15 bucks, IIRC, which may be more efficient than one time payments if you're going to check it regularly.
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Thanks ARS for your helpful reply. You are completely correct that I do not need to run my credit report more often, I'll just need the numbers. What does IIRC stand for?
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I'm sure the advanced Mustachians here already know this, but be wary of checking up on your credit score too often. Multiple inquiries can cause it to be lowered.
I never keep track of my score, but I recently bought a house with a primary conforming mortgage and a HELOC (given my tax bracket, I benefit from the mortgage interest tax deduction). Both lenders were required to disclose the scores they used to set my rate. The HELOC was the second loan approved, and my credit scores were lower. The only new reason cited was that I had too many inquiries on my record. It was not significantly lower, and had no impact on the interest rate I was given, but I suppose it could have had I been more of a borderline case.
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What does IIRC stand for?
If I Recall Correctly
When you pay for your credit score, be sure to get a Fico score. As I'm sure you know, there are many vendors selling their own variant/version of the score. I've never bothered to pull my own, but I understand that MyFico is the place to go to get your Fico scores.
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I'm sure the advanced Mustachians here already know this, but be wary of checking up on your credit score too often. Multiple inquiries can cause it to be lowered.
I never keep track of my score, but I recently bought a house with a primary conforming mortgage and a HELOC (given my tax bracket, I benefit from the mortgage interest tax deduction). Both lenders were required to disclose the scores they used to set my rate. The HELOC was the second loan approved, and my credit scores were lower. The only new reason cited was that I had too many inquiries on my record. It was not significantly lower, and had no impact on the interest rate I was given, but I suppose it could have had I been more of a borderline case.
That's only if you're applying for credit and someone ELSE is checking your credit. Then too many inquiries (about opening new lines of credit) hurt your score. If you check your score, it's called a soft pull instead of hard pull, and it doesn't affect your score in the slightest. Doesn't apply in the OP's situation.
Also herisff is correct on both IIRC and FICO score.
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I'm sure the advanced Mustachians here already know this, but be wary of checking up on your credit score too often. Multiple inquiries can cause it to be lowered.
I never keep track of my score, but I recently bought a house with a primary conforming mortgage and a HELOC (given my tax bracket, I benefit from the mortgage interest tax deduction). Both lenders were required to disclose the scores they used to set my rate. The HELOC was the second loan approved, and my credit scores were lower. The only new reason cited was that I had too many inquiries on my record. It was not significantly lower, and had no impact on the interest rate I was given, but I suppose it could have had I been more of a borderline case.
That's only if you're applying for credit and someone ELSE is checking your credit. Then too many inquiries (about opening new lines of credit) hurt your score. If you check your score, it's called a soft pull instead of hard pull, and it doesn't affect your score in the slightest. Doesn't apply in the OP's situation.
Also herisff is correct on both IIRC and FICO score.
This is why a little knowledge is a dangerous thing. I stand corrected.
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This is why a little knowledge is a dangerous thing. I stand corrected.
That's why we're here; to share information and learn. I've stood corrected a dozen times or more on these forums so far. ;)
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Those give you a credit report, but not a score.
So it's just the data that the CCRAs use to calculate your score and not your calculated score itself that you're entitled to?
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Get Rich Slowly recommends Credit Karma, which gives some sort of score. I have no idea whether it's a real score or one of their own making.
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Those give you a credit report, but not a score.
So it's just the data that the CCRAs use to calculate your score and not your calculated score itself that you're entitled to?
Correct, it's your credit report, which lists your accounts, time opened, payment history, etc. Not a score.
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Get Rich Slowly recommends Credit Karma, which gives some sort of score. I have no idea whether it's a real score or one of their own making.
Credit Karma gives you a score based on your Transunion score; credit sesame gives a score based on your Experian report; and the actual Fico score is a product sold by Equifax. Credit Karma and Credit Sesame will give you a good idea of what your score is without having to pay for it.
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I'm sure the advanced Mustachians here already know this, but be wary of checking up on your credit score too often. Multiple inquiries can cause it to be lowered.
I never keep track of my score, but I recently bought a house with a primary conforming mortgage and a HELOC (given my tax bracket, I benefit from the mortgage interest tax deduction). Both lenders were required to disclose the scores they used to set my rate. The HELOC was the second loan approved, and my credit scores were lower. The only new reason cited was that I had too many inquiries on my record. It was not significantly lower, and had no impact on the interest rate I was given, but I suppose it could have had I been more of a borderline case.
There is a difference between a "soft" inquiry (you checking your own score), and a "hard" inquiry (mortgage lender or CC company inquiring about your creditworthiness before extending credit); namely, the first does not impact your score, whereas each hard inquiry causes your score to drop anywhere from 2-5 points.
Also, mortgage lenders tend to run an inquiry with all 3 major credit reporting agencies, whereas credit card companies usually make just one inquiry (unless it's CapOne, which routinely pulls all 3 reports when you apply for a CC).
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I thought if you have a 720+ FICO score you would automatically qualify for the best possible interest rate? Someone please correct me if I'm wrong.
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I thought if you have a 720+ FICO score you would automatically qualify for the best possible interest rate? Someone please correct me if I'm wrong.
It's usually 750. 720 is the second tier below that. But that's for mortgages. I believe it can also depend based on the product (P2P loan, for example).
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I haven't posted here simply because my view has been covered, I think it's a waste of time and money.
Having said that, I'll be interested in the results. But I also have to assume this has been done before and reported on many times. A simple search pointed to many articles with titles suggesting it has been done, but I'm not going to spend a ton of time reading them. Anyway, I assume the result will be a slight uptick to your score without any actual benefit. Hopefully you will get what you wanted out of the process though, good luck and let us know how it turns out!
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I thought if you have a 720+ FICO score you would automatically qualify for the best possible interest rate? Someone please correct me if I'm wrong.
It's usually 750. 720 is the second tier below that. But that's for mortgages. I believe it can also depend based on the product (P2P loan, for example).
720 used to get you the best rates, but not after the credit crunch. "Today's 760 is what a 720 used to be." http://www.bankrate.com/finance/credit-cards/what-s-a-good-credit-score.aspx
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Wow! Thanks for all the input, everyone.
I l-o-v-e IIRC. Now that I know what it means, I'll probably use it a lot, as my memory stinks. So then, does "I stand corrected" = ISC? Because I do that a lot, too.
Note to James, you are correct. I did several searches and spent a chunk of time sifting through a lot of crap, but couldn't find a definitive answer. Most of it was aimed at Stupid Consumers, of whom there are very few in these parts :)
I know my quest is a bit esoteric, which is why I turned to the sharply pointed moustache-ian minds here for help. You did not disappoint. Thank you.
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Keep in mind that not everyone's goals are the same.
Personally, I'm looking to retire once I have 1MM in liabilities.
One path that I may likely take is to NEVER pay off a mortgage, eventually acquire over 20 of them, and refi them to longer terms to take cash out when they get paid down.
Mathematically it's far, far superior to paying them off.
Not everyone is anti-debt.
Interesting strategy - any place you can point me to that discusses this and shows the math?
Thanks!!!
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Interesting strategy - any place you can point me to that discusses this and shows the math?
Thanks!!!
Try arebelspy's post (https://forum.mrmoneymustache.com/investor-alley/get-rich-with-a-mortgage!/msg8477/#msg8477) on the matter (may want to read up the thread for more context...)
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Keep in mind that not everyone's goals are the same.
Personally, I'm looking to retire once I have 1MM in liabilities.
One path that I may likely take is to NEVER pay off a mortgage, eventually acquire over 20 of them, and refi them to longer terms to take cash out when they get paid down.
Mathematically it's far, far superior to paying them off.
Not everyone is anti-debt.
Interesting strategy - any place you can point me to that discusses this and shows the math?
Thanks!!!
grantmeaname nailed it.
And actually someone just PM'd me the same question this morning. The following is what I sent to them as a reply.
Hah! That's a good question.
Having mortgages is indeed mathematically superior, and if you want to actually get rich you'll want to use leverage like that - basically every non-lotto winner successful businessman does. I don't care about getting rich, but I do care about hitting FI as fast as possible.
The advantage comes from a combination of three things:
1) Leverage - discussed in this MMM post here:
http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/
Specifically read "Strategy 2" in that article. I'm the one who wrote the post he quotes. Essentially leverage (i.e. having a mortgage) will let you earn more money in a variety of ways (more tax advantages via depreciation, more cash flow, more principal paydown - obviously, and more appreciation if any happens, mortgage interest writeoff, etc.). It's mathematically much better.
2) Inflation protection - as the dollar is worth less, such that more dollars are being printed, your fixed mortgage becomes smaller and smaller as a percent of your spending. So let's say your mortgage payment is $1000. Bread is $2, gas is $5. Now inflation hits, stuff doubles in price over a few years. Bread is $4, gas is $10, and your mortgage is... still $1000. Effectively it costs you HALF as much in real dollars due to inflation. (And rents will go up, meaning if you rent your payment is higher, but not if you own a mortgage, and if you rent it out to someone, you'll make more, but not have to pay more.) Having no mortgage, you aren't saving anything in your budget. But the mortgage helps protect you from inflation.
3) TAX FREE gains. As I outlined in this thread: https://forum.mrmoneymustache.com/investor-alley/get-rich-with-a-mortgage!/
You can continually refinance to gain the market value . This further protects you from inflation (because the refi amount rises with inflation), but just as important, the amount you pull out from refinancing isn't income. So you don't get taxed on it! If you just have one house, you'd only refinance every 24 years or so (once it's doubled in value). Now imagine you have 24 houses, such that you can refi one per year. That's 100k (in the example below, or whatever the nominal value of the house is) per year, tax free.
My post in that thread, to help explain a little more, said:
Sure, I think that could be a great idea. For me, it likely won't matter, because I'm planning on refinanacing every so often (even at *gasp* higher future rates) in order to tap equity. With home prices growing to (roughly) equal inflation, your 100k home, at 3% inflation per year, will be worth roughly 326,000 in 40 years. That's money sitting I'd rather have access to.
Though your strategy might be good for if you are just having your one (primary) residence.
Refinancing works especially well with rentals. Refinancing gets you money out TAX FREE.
Here's an amazing strategy. Say you have 24 rentals worth 100k each. Rule of 72, 3% inflation means they double in value every 24 years. You do a mortgage ladder where one is 30 years from paying off, the other 29, the next 28, etc. and so on down. Each year, you refi the one that is closest to paying off to max out the term. You gain all the untapped equity. The next year, you refinance the next one, and so on, each year, until you get back to the first one. 24 years later. By that time, it's approximately doubled in price. You refi to take out 100k (in 2011 dollars) tax free. The next year, house #2, which has doubled since you last refi'd it, you tap 100k in today's dollars.
Every single year your refinance gets you what the house is worth, in today's dollars, completely tax free.
As long as the rent covers the mortgage (and since rents rise with inflation, if you bought it right and kept it up, it should), you are gaining the value of one of the houses every year into your pocket tax free. Aside from any cash flow the house itself provides.
I'd take 100k/year, inflation adjusted, just for filling out refinancing paperwork once/year.
...but that's a separate side tactic.
So those are some reasons why mortgages are superior to free and clear. Sure, being debt free (including "owning" your house - though it can get taken by an HOA, government via eminent domain, not paying taxes, etc.) gives you a warm, squishy feeling. But it sure won't make you as much money. So me? I'll load up on debt, as long as I'm comfortable with the ability to repay. Because frankly I'd rather pay a little interest and let the bank earn some money if it will make me even more money!
Hope that helps/makes sense.
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Thanks, arebelspy!
On one hand, this looks like a possible subject hijacking, on the other, even if it is, it suits me perfectly! I am 100% convinced of the value of taking out a big mortgage and not paying it off early. I am a SAVER, but I live in an expensive area and housing is a huge percentage of my budget. If I am to make all my other goals, dumping my cash into the house is not my best option. The whole concept of paying today vs. repaying back with inflated dollars is lost on most folks. It's kind of like playing the "Don't Pass" line in Craps. Your odds are better, but you're doing the opposite of most everyone else at the table. And yes, I know gambling is not frugal and I haven't done much of it since my college days, but I understood the rules of the game and rarely came up short. Tell me that all the folks who bought more house than they could afford with mortgages they didn't understand weren't gambling. Worse, they did it with money they didn't have and couldn't afford to lose. And now I'm supposed to cry for them as they walk away from their mortgages that (in a number of cases) they can still afford but don't want to any more because they owe more than it's worth. Boo-Hoo.
One of the many lessons that brought me to your conclusion was fairly serendipitous. One Saturday, I paid my mortgage and proudly included for the first time an extra $100 principal payment. My next stop was the library. While browsing the New Books section, I came upon Ric Edelman's "Ordinary People, Extraordinary Wealth". It is no exaggeration to say that the book is one of the best financial books I've ever read.The first chapter explains this mortgage theory clearly and concisely. It was not the first time I'd heard this concept, but it helped me finally understand it. I highly recommend it to anyone wanting to learn more about how mortgages can work for you.
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Let me see if I have this right. The basic idea is that you can get a perpetual, tax-free mortgage that periodically adjusts for inflation, and this is good because you can find conservative investments that beat your mortgage rate.
How big is the effect? If I have the cash to buy a rental property, but I borrow instead, and I can get an 8% ROI on the rental and an 8% return on investments, what would the total return with this strategy be?
While browsing the New Books section, I came upon Ric Edelman's "Ordinary People, Extraordinary Wealth".
Thanks for the recommendation; I have requested this book from the library.
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How big is the effect?
Nevermind. I see it in the blog post (http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/).
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How big is the effect?
Nevermind. I see it in the blog post (http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/).
Yes, that scenario two is based off an earlier post I wrote, and shows some of the benefits. This refinancing idea to pull out tax-free money is a separate idea, that's equally powerful.
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why do you need a good credit score? once your debt is paid, you should NEVER need credit again!
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Hey, "Bro",
The time to improve your credit score is before you need it. It's process that takes time. I'd liken it to planting crops or building a big, fat emergency fund. They're both "just in case" and must be started well before the presence of need.
I'm been reading MMM since the beginning (alas, I still forget there's no "o" in "mustache"). This is the first question I've posted on the forums. I have been amazed at how little criticism there has been. The very thought-provoking feedback I received here helped me make what I believe is a good decision, but only time will tell.
While I do appreciate that you took the time to reply; was your comment meant to be helpful?
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why do you need a good credit score? once your debt is paid, you should NEVER need credit again!
Apparently you didn't read the thread. This question was answered multiple times, in different posts. Here's one example:
WTF is peoples obsession with their credit score - why do you care? Are you planning to take out a major loan in the next three years, is your current one rubbish?
Because of the thousands of dollars it can save you or make you.
Small example: Right now lots of people are complaining about trying to get loans for housing, that the credit markets are tight. Despite that, of the 5 houses I've purchased in the last few years, I've got loans on three of them due to my excellent credit scores. (The other two were purchased with cash.) Just like cash gives you opportunities, so does good credit, by giving you access to leverage and other people's money. It's not for everyone, but it can be advantageous if you are smart about it.
I don't "obsess" about it. In fact, I've never done anything to actively say "this will boost my credit score" that I wasn't doing otherwise. However I wouldn't do something that would hurt my score, because I actively use it to make me money.
...so sure, you could pay off all debt and never use credit. That is the way to go for some people.
OR you could utilize it in a smart, careful way and make way more money and hit financial independence WAY earlier!
I personally choose the latter.
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Hey, "Bro",
The time to improve your credit score is before you need it. It's process that takes time. I'd liken it to planting crops or building a big, fat emergency fund. They're both "just in case" and must be started well before the presence of need.
I'm been reading MMM since the beginning (alas, I still forget there's no "o" in "mustache"). This is the first question I've posted on the forums. I have been amazed at how little criticism there has been. The very thought-provoking feedback I received here helped me make what I believe is a good decision, but only time will tell.
While I do appreciate that you took the time to reply; was your comment meant to be helpful?
It's a common question he had. He just didn't bother to read that it was already addressed. But I'd be happy to discuss the merits of debt free versus smart debt utilization with him once he has done so.
I don't think jabs at his username help the conversation any either. ;)
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why do you need a good credit score? once your debt is paid, you should NEVER need credit again!
Given all the above discussion about how refinancing can help you get to FI faster, I take it this is a joke.
And if your personal philosophy is to pay down debt quickly, you'll never need credit again right after you take out your last loan, long before your debt is paid off.
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"I don't think jabs at his username help the conversation any either. ;)"
Sorry it looked like a "jab" to you. I thought his handle was funny and clever, as both of my brothers are referred to as "Bro" in my family, and my dad is "Pops". So many conversational subtleties are lost in the blogosphere...Apologies to those who read it differently than intended.
Still haven't figured out the quote thing.
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Ah, I gotcha!
Nowadays the word "bro" is synonymous with "douchebag." And the quotes around the word bro made it also look sarcastic.
Take a look at the first three definitions:
http://www.urbandictionary.com/define.php?term=bro
(The first part of definition 1 is what you mean, but the second part of definition one, definition 2, and definition 3 are the most common definition nowadays - and the quotes helped make it seem that's what you were going for).
No worries if that's not what you were intending, thanks for clarifying. :)
To quote something, just hit the "quote" button in the upper right of that post that you want to quote.
Or, when replying, go down to the replies (under the box you're typing in) and hit "insert quote".
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Holy Crap! I am getting old. To add to the tale a bit: to distinguish/diminish him, my older "Bro" called our younger "Bro" "pud", probably an earlier version of db from the olden days when boys would never dare utter the word douche or any of its lovely variations publicly. Imagine my surprise when my Real Estate Broker informed me that the townhouse I was about to buy was legally referred to as a "PUD". Eleven years later it still makes me laugh and think of my brother's antics when we were growing up. A long time ago, indeed!
Thanks for the quote tips.
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I call people bro all the time, it's all in how you say it. Which, on the internet we lack voice inflection so the quotes seemed to say it in 'that way' which suggests the douchebag connotation. Looks like we've beaten that dead horse though. :)
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One of the many lessons that brought me to your conclusion was fairly serendipitous. One Saturday, I paid my mortgage and proudly included for the first time an extra $100 principal payment. My next stop was the library. While browsing the New Books section, I came upon Ric Edelman's "Ordinary People, Extraordinary Wealth". It is no exaggeration to say that the book is one of the best financial books I've ever read.The first chapter explains this mortgage theory clearly and concisely. It was not the first time I'd heard this concept, but it helped me finally understand it. I highly recommend it to anyone wanting to learn more about how mortgages can work for you.
Thanks for the recommendation Diane. I checked it out from the library on your recommendation.
It doesn't describe the refinancing idea I was discussing, but it does give many, many good arguments for why one ought to carry a mortgage and invest any money they'd put towards paying down the principal.
The rest of the book was pretty good as well.
Definitely worth the read for anyone, but especially someone who is on the fence about paying down a mortgage or not (I.e. not an anti-debt zealot).
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Wow! ARS, that's a quick response. I love how clearly Ric Edelman explains complex topics. I just finished listening to the podcast of last week's radio show, in which Ric mentioned that this topic is covered in a Forbes article this week, so here is the link:
http://www.forbes.com/sites/financialfinesse/2012/05/08/why-you-might-never-want-to-pay-your-mortgage-off/
Lots of good stuff to think about!
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Not sure whether this is stretching the original topic, but it seems worthwhile to point out that the higher returns you get from leveraging reflect the higher risk you are taking. It is entirely possible for leveraging to trip you up either a) if at some point your money is earning a lower return elsewhere or b) the asset upon which you are leveraged stops earning the anticipated income, which is particularly relevant if you own a single rental property. You can de-risk by having assets in various locations / asset classes (don't forget you can leverage on assets other than property).
There is nothing like having to find the mortgage payment each month on an empty property ;)
So........ when comparing potential returns PLEASE always at least acknowledge the risk element of leveraging, even if you don't do the full maths behind it.
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Leveraging will maximize your profits and increase your losses.
It's not a completely rosy picture as you describe.
DA
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Thanks for the recommendation Diane. I checked it out from the library on your recommendation.
I also picked it up and skimmed it this weekend. It seemed like the author was recommending having a big mortgage, too, as in a big house, which doesn't sound right. It would be best to keep your own housing expenses low and get more mortgages through owning rentals, if so desired.
It feels odd to be seconding real estate advice from a book that came out in 2001.
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Real estate and the markets are cyclical. They go up and down. Too be leveraged in 2007 and 2008 on real estate may not have been a good idea depending on where said real estate was located.
Obviously after a big drop in real estate, bargains were to be had by those unfortunate souls who leveraged themselves to the hilt.
So now leverage into a bargain may be a good financial decision. However, ask those who were leveraged in 07, 08 and you may get a different answer.
DA
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Real estate and the markets are cyclical. They go up and down. Too be leveraged in 2007 and 2008 on real estate may not have been a good idea depending on where said real estate was located.
Obviously after a big drop in real estate, bargains were to be had by those unfortunate souls who leveraged themselves to the hilt.
So now leverage into a bargain may be a good financial decision. However, ask those who were leveraged in 07, 08 and you may get a different answer.
If they were speculating, sure.
If they were cash flow positive and basing their purchase on solid fundamentals, and not appreciation speculation, they're not hurting too bad.
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"It seemed like the author was recommending having a big mortgage, too, as in a big house, which doesn't sound right."
Funny you should mention that. On last Saturday's radio show (which I listen to via podcast on Sundays to avoid evil advertising) Ric clarified that that big, long mortgage should only be attached to a house you can afford. He is not advocating overspending on said house in the first place. So, if you want/need/can afford a big house, go for it, but make sure to get a big, fat, cushy fixed-rate mortgage, especially now, while interest rates are so skinny minnie. And be sure to save and invest the difference.
Glad you liked the "old" financial book. He's written a number since, but OP/EW is still my favorite.
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Here's an update on the loan story: I paid off about half the loan yesterday. I couldn't stand to wait until 30 days had passed. Since the billing cycle had closed, I went ahead and moved $2600 from the sub-account I established with the loan proceedings. Now my utilization is under 50%. The monthly payments are set up automatically, so they will proceed until the loan is paid off in 11.5 months. If I can stand to wait that long. It's too soon to run my credit, I'll probably wait until the six month mark to peek at the scores. Thanks again for all the advice.
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Leverage does increase risk of larger losses, but in business can reduce risk and boost returns. But borrowing to live in a big house or drive an expensive car is not leverage. It's debt. You can't use the 'but I get 5% return on my other investments and this only costs me 3%!' argument.
Unless you are renting the property, you're consuming it by living in it. Relying on increasing house prices to pay off the loan is silly (you still have to live somewhere), and doesn't change your net gain (as recently posted by MMM?)
So, leveraging productive capital can work. Borrowing to consume is non-Mustashian.
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Hi Mr. Mark,
Thanks for chiming in, but I'm a bit confused. Fortunately, it's a fairly normal state for me, so if the answers to my questions are obvious, I beg your forbearance. I'm fairly certain this post is not about leverage. As the title states, it has to do with increasing credit score. Specifically, the possibility of increasing my credit score. The thread has taken some interesting turns along the way, but this concept of leverage is a complete curveball.
Did I use the " 'but I get 5% return on my other investments and this only costs me 3%!' argument"?
Was it clear that I am not a renter?
Was it also clear that I have the cash to spare?
Did I ever state that I was "Relying on increasing house prices to pay off the loan"?
Does a used minivan which was my former company car-which-I-paid-cash-for-and-can-also-write-off-the-interest* count as an "expensive car"?
*AHA! I don't think I had considered this point until now: I am paid a stipend which in no way covers the actual cost of operating said vehicle to conduct company business. I completely forgot that I can write off all unreimbursed auto expenses (See how spoiled I was to have a company car all those years? Good thing I saved the difference.) So apparently I'm attempting to boost my credit score for no net cost. Yippee! Can this really be true? Fortunately, I pay a CPA (very mustachian) to keep me on the right side of the tax laws. If I can't write it off, he'll be sure to set me straight.
When I began writing what I thought would be a rather short post, I was struggling mightily for the words to phrase my response tactfully. Whilst biting my tongue, I realized that this whole experiment might actually be tax-deductible! So Thank You Very Much Mr. Mark, but please remember that this forum is designed for us to assist each other. It helps to read the subject question thoroughly and at least scan the responses if you're going to take the time to compose and post a reply. If I am being an idiot (or as my boss likes to say: eye-dee-ten-tea) and I have asked for advice, you are free to reply, but please do so nicely. Staying on or around the subject is also appreciated.
I've come to my own conclusion with the help of some very wise Mustachian input (and learned how to spell the M word correctly in the process). I'm one who likes to hear the rest of the story, so I'm posting progress reports until I figure out if the tactic actually worked.
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He was replying to the conversation higher up by Devils Advocate and others, not your specific question.
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Leverage does increase risk of larger losses, but in business can reduce risk and boost returns. But borrowing to live in a big house or drive an expensive car is not leverage. It's debt. You can't use the 'but I get 5% return on my other investments and this only costs me 3%!' argument.
Unless you are renting the property, you're consuming it by living in it. Relying on increasing house prices to pay off the loan is silly (you still have to live somewhere), and doesn't change your net gain (as recently posted by MMM?)
So, leveraging productive capital can work. Borrowing to consume is non-Mustashian.
I strongly disagree with multiple things you said. Yes, borrowing to consume is non-Mustachian, but you have to live somewhere, so you might as well do it in the mathematically best way possible. (That of course includes not getting a bigger place than you need.) And the best way possible is using a mortgage, especially at today's rates.
The biggest part I disagree with (and your basic argument):
You can't use the 'but I get 5% return on my other investments and this only costs me 3%!' argument.
Of course I can! You do the math, decide that where you live it's much cheaper to own than rent, so you buy.
Scenario one: You have the cash to purchase it outright. Or you can put it in an investment that averages 5% over the next 30 years (your number.. I'd be shocked if you couldn't earn higher than that over the next 30 years, at least 7-8). Getting the (tax deductible) 3% mortgage and keeping the difference invested will net you much more over the next 30 years.
Scenario 2: You don't have the cash, so you're forced to get a mortgage. Then you get some extra cash, and think about paying it down. Or you could invest it. The latter is better.
I don't know why you say you can't use that argument on your primary residence. Of COURSE you can use it.
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To clarify, I'm not saying your primary residence is an investment. It's not (unless you rent out some of it or something.)
It's a necessary place to live. But when you have money to invest, you could either invest it in paying down 3%, tax deductible debt (where it immediately gets trapped) or you could invest it in a 5% earning, compounded investment (where it's easily accessed and is liquid). I'd choose the latter.
The fact that the debt is a mortgage on your primary residence is irrelevant to the decision. Thus my issue with the quoted sentence.
Appreciate your viewpoint though, and I know not everyone will agree with me. :)
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He was replying to the conversation higher up by Devils Advocate and others, not your specific question.
That was not clear to me, as I indicated. Regardless, I am grateful to him for the A-Ha! moment that his comment sparked. He made my day. I think it will be a lot easier to let this loan play out, knowing that the interest is tax deductible.
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To clarify, I'm not saying your primary residence is an investment. It's not (unless you rent out some of it or something.)
It's a necessary place to live. But when you have money to invest, you could either invest it in paying down 3%, tax deductible debt (where it immediately gets trapped) or you could invest it in a 5% earning, compounded investment (where it's easily accessed and is liquid). I'd choose the latter.
The fact that the debt is a mortgage on your primary residence is irrelevant to the decision. Thus my issue with the quoted sentence.
Appreciate your viewpoint though, and I know not everyone will agree with me. :)
Arebelspy,
What I was trying to say [poorly, and totally off thread] was that the decisions on spending for consumption should be seperate from the decisions on how to finance it. There should almost be a 'chinese wall' between the two sides of the household accounts.
Too often a low interest rate on a loan is used to justify the amount of debt taken on for for the purchase itself - and you end up with a bigger house, bigger car(s), new furniture. This increases your consumption, especially because the house you live in is primarily a consumable expense, not an investment.
On the financing side, the goal is as rapid a growth in Stash as possible. Yes, if you can borrow at 3% after tax, and invest (with no risk) at 5-7% after tax - within limits I'm sure you're aware of - that is of course usually a good thing (but is not as easy as it looks). And in businesses this leveraging is usual, and lowers risk, but is almost always to do with capital expenses.
Diane C,
Was totally refering to a comment earlier, off thread, apologies. Didn't mean to set you off!
As for your loan, I don't think it's a big deal. The marginal benefit of a rise from 800 to 800+ is low but not zero, and the fees and trouble of your loan seems a bit of an effort to me. But the after-tax cost for a short period on a small loan will be tiny. So, why not?
What I would question is your "18 month EF" statement in the original post. 18 month emergency fund? That looks like a place some effort on your financials would pay big time.
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Too often a low interest rate on a loan is used to justify the amount of debt taken on for for the purchase itself - and you end up with a bigger house, bigger car(s), new furniture. This increases your consumption, especially because the house you live in is primarily a consumable expense, not an investment.
Ah yes, good point.
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Too often a low interest rate on a loan is used to justify the amount of debt taken on for for the purchase itself - and you end up with a bigger house, bigger car(s), new furniture. This increases your consumption, especially because the house you live in is primarily a consumable expense, not an investment.
Ah yes, good point.
I hope on re-reading my earlier post you can see what I meant, and I think we're in violent agreement. I shudder at the idea of Arebelspy disagreeing with multiple things I say!
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Yes, it absolutely makes sense now! I totally misinterpreted it.
Though I like when people disagree with me. As long as they're able to do it without getting offended, I often get along with them better, despite our disagreements.
But no, I very much agree the "but I can invest at higher" to load up on consumer debt (and then not invest) is a terrible argument.
Although I like the idea of "violent agreement"-- like we're coming to blows agreeing with each other! :D
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On the financing side, the goal is as rapid a growth in Stash as possible. Yes, if you can borrow at 3% after tax, and invest (with no risk) at 5-7% after tax - within limits I'm sure you're aware of - that is of course usually a good thing (but is not as easy as it looks). And in businesses this leveraging is usual, and lowers risk, but is almost always to do with capital expenses.
This man knows his beans.
I would be interested to know how it lowers risk however.... ;) I would suggest the least risky route is the no debt route and finance your investments (whether you're an individual or a business) from generated cashflow. If you have a link detailing how it reduces risk I would be very interested.
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We're well off thread now.
Leveraging can (but doesn't always) reduce risk, because it enables a bigger spread of investment for the same capital.
So, if you're renting properties, instead of owning say, 1 property outright, you could leverage and own 2 or 3 rentals. This increases return of capital (borrow at 4%, rental return say 10%) and means all your eggs are not in one property. Plus with more rentals, you are less dependent on any individual tenant or vacancy.
No Leverage
1 house at 100k, rented for a net return of 10%, 10k income per year
Leverage?
3 houses at 100k, borrow 200k
Gross return is now 30k, less 12k mortage payments, 18k income per year!
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I would suggest the least risky route is the no debt route and finance your investments (whether you're an individual or a business) from generated cashflow.
Least risky? Possibly.
Sub-optimal? Definitely. Why do you think many companies who hold Billions in cash still borrow money?
Rates are so low companies are borrowing money to keep it in cash to utilize when rates rise.
http://www.nytimes.com/2010/10/04/business/04borrow.html?pagewanted=all
http://www.usatoday.com/money/companies/management/story/2011-11-26/myth-of-corporate-cash-piles/51346848/1
So maybe being debt free is the least risky (maybe). But it's not the way most businesses do it, for good reason.
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Thanks for that Mr Mark - very neatly explained. It does move you down the risk scale, although one wonders how far, given that it is a single asset class and one assumes in a single region (otherwise costs would increase).
Are the figures accurate? Here in the UK the interest rate is probably accurate at 6% but the net income figure at 10% looks kind of on the high side (unless you're investing in areas with higher proportion problem tenants). A good gross with student/young professional tenants around here is 7-8%.
I would suggest the least risky route is the no debt route and finance your investments (whether you're an individual or a business) from generated cashflow.
Least risky? Possibly.
Sub-optimal? Definitely. Why do you think many companies who hold Billions in cash still borrow money?
Rates are so low companies are borrowing money to keep it in cash to utilize when rates rise.
http://www.nytimes.com/2010/10/04/business/04borrow.html?pagewanted=all
http://www.usatoday.com/money/companies/management/story/2011-11-26/myth-of-corporate-cash-piles/51346848/1
So maybe being debt free is the least risky (maybe). But it's not the way most businesses do it, for good reason.
arebelspy - I have not disputed it is sub-optimal - I just get nervy when people don't look at the risk element when talking up leveraged returns. I have seen too many folks look at leveraged returns from property and say "Hey, look at what I am making compared to sticking this money in a bank account"
Even Mr Marks response to me focused on the higher return - as evidenced by his exclamation mark..... ;-)
However, I am willing to accept I may have a skewed view as I've owned a leveraged investment property in the past. The housing boom saw lots of luxury apartments built in the area, which dropped the yield on my (older) apartment. Being realistic about costs (another area I think people considering property investment underestimate) it pushed me below break-even. Luckily that was 2005 and I sold out before the market crashed.
I work in corporate finance so have to look at both sides of the equation around borrowing to fund a business. Borrowing instead of using equity reduces the weighted average cost of capital for my business and improves shareholder returns. However unlike many individuals, my business has an accountant (me!) to produce forward cashflows, scenario modelling and summary financials and ratios to properly understand the impact of using debt to fund investment activities.
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I would suggest the least risky route is the no debt route and finance your investments (whether you're an individual or a business) from generated cashflow.
Least risky? Possibly.
Sub-optimal? Definitely. Why do you think many companies who hold Billions in cash still borrow money?
Rates are so low companies are borrowing money to keep it in cash to utilize when rates rise.
http://www.nytimes.com/2010/10/04/business/04borrow.html?pagewanted=all
http://www.usatoday.com/money/companies/management/story/2011-11-26/myth-of-corporate-cash-piles/51346848/1
So maybe being debt free is the least risky (maybe). But it's not the way most businesses do it, for good reason.
The idea that corporations are flush with cash is a popular myth:
http://globaleconomicanalysis.blogspot.com/2012/05/cash-cow-liquidity-comparison-wheres.html
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I would suggest the least risky route is the no debt route and finance your investments (whether you're an individual or a business) from generated cashflow.
Least risky? Possibly.
Sub-optimal? Definitely. Why do you think many companies who hold Billions in cash still borrow money?
Rates are so low companies are borrowing money to keep it in cash to utilize when rates rise.
http://www.nytimes.com/2010/10/04/business/04borrow.html?pagewanted=all
http://www.usatoday.com/money/companies/management/story/2011-11-26/myth-of-corporate-cash-piles/51346848/1
So maybe being debt free is the least risky (maybe). But it's not the way most businesses do it, for good reason.
The idea that corporations are flush with cash is a popular myth:
http://globaleconomicanalysis.blogspot.com/2012/05/cash-cow-liquidity-comparison-wheres.html
Yes! That article exactly proves my point. They could pay off ALL that debt. Yet they choose not to do so, they still hold all that debt in order to hold cash.
The point is that they are flush with cash. They have 4.55 Trillion in cash. The fact that they have 4.50 Trillion in liabilities is because they use leverage and hold debt.
If they wanted, they could pay off that debt and operate off cash flows (not all, but many). They don't, though, despite holding 4.55 Trillion in cash.
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Yes! That article exactly proves my point. They could pay off ALL that debt. Yet they choose not to do so, they still hold all that debt in order to hold cash.
The point is that they are flush with cash. They have 4.55 Trillion in cash. The fact that they have 4.50 Trillion in liabilities is because they use leverage and hold debt.
If they wanted, they could pay off that debt and operate off cash flows (not all, but many). They don't, though, despite holding 4.55 Trillion in cash.
Exactly. By "myth" I was referring to the idea that corporate America is sitting on trillions of cash free and clear. Fact is they only have cash because they've issued debt to acquire it. In the context Shedlock is writing, the reality of the corporate balance sheet precludes the idea of companies stepping into the stock market and buying their stock hand over first.
As he states, sentiment moves markets, and not cash levels -- real or fictitious.
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Thanks for that Mr Mark - very neatly explained. It does move you down the risk scale, although one wonders how far, given that it is a single asset class and one assumes in a single region (otherwise costs would increase).
Are the figures accurate? Here in the UK the interest rate is probably accurate at 6% but the net income figure at 10% looks kind of on the high side (unless you're investing in areas with higher proportion problem tenants). A good gross with student/young professional tenants around here is 7-8%.
....
I work in corporate finance so have to look at both sides of the equation around borrowing to fund a business. Borrowing instead of using equity reduces the weighted average cost of capital for my business and improves shareholder returns. However unlike many individuals, my business has an accountant (me!) to produce forward cashflows, scenario modelling and summary financials and ratios to properly understand the impact of using debt to fund investment activities.
No, the figures were just to make the example clear, although they're not far off. In reality it would probably be even better because the interest payments would be tax deductable. And the foreclosure problem in the US has created a real buying/investment opportunity for rentals, with lower prices for rental units and more demand from tenants. If you find the right deal, yields can even be much higher than 10%.
And I agree, getting into leveraging can be complicated for individuals to manage, and investors need to be wary of over-leveraging, especially if they forget about cash flow... leveraging increases returns on capital employed when things are good, but also means a small drop in asset value can wipe out your equity completely.
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So far off topic, and yet so interesting! I am certainly enjoying the ride. Thanks for all the ideas and good conversation. I love "violent agreement"!