Debt seems to give a negative impression. Sometimes it even gives people the chills just by hearing the word. But what is debt? Both layman and business dictionaries define debt as something that someone has given permission to borrow but with conditions to repay.
Now when it comes to organisations around the world, debt is used as an engine that creates financial leverage and multiplies yield on investment; provided returns generated by debt exceed its cost because the interest paid on debt can be written off as expenses.
Looking at this, is debt a good thing? Does debt put you in a better position or worse? Does debt make you RICHER or POORER? The answer is: “It depends!”
Poor Debt
We have seen tremendous growth in lifestyle expenditure. The unfortunate part of this culture is the increase of debts which makes people poorer. Let’s take the credit card as an example; 40% of credit card holders’ debt revolve around their credit, which means they only pay the minimum or part of the due amount after spending in full every month.
This trend has been rising for some time now. When you spend beyond your means and revolve unnecessarily, especially on lifestyle lavishness, you are paying a high price for your indulgences as the payback for your expenditure is compounded by a whopping 18% per annum.
To make matters worse, most of these lifestyle extravagances depreciate in value.
Responding to this trend, the personal loan product emerged as another form of new age credit. It gives easy cash access as it requires no asset pledged or charged as security. Many people are attracted to this sudden access to large volumes of cash that can be used for anything desired.
What’s more, its fixed low monthly payback instalment makes borrowers believe they have more control of their finances this way. The personal loan is another lending facility that gives the after effect of one week of pure enjoyment and five to seven years of dreadful commitment.
Running a debt on a credit card and personal loan is EXPENSIVE. It will cost you three to four times MORE than a home loan / mortgage.
In a nutshell, a poor debt is basically spending your future money for current or past expenditure and it does not generate anything for your future.
Rich Debt
Please see the situation below on how a debt that can make you richer.
John buys the same asset worth RM1M, and after three years, he also sold it at RM1.2M and made a handsome profit of 20%. He paid the entire asset of RM1M in cash. This was his capital outlay.
Amanda buys an asset worth RM1M, and after three years, she sells it for RM1.2M, making a handsome profit of 20%. She had the cash to buy the asset but she took a loan to finance 90% of the asset. Her capital outlay was only RM100,000.
Who is a smarter investor? Who made more money? Who is financially more resilient?
- Amanda only used RM100,000 to make RM200,000 in three years.
- While on the other hand John used RM1,000,000 to make RM200,000 over three years.
Amanda applied the power of SMART Leveraging. Amanda leveraged using debt, which she intentionally created, and a debt that is clearly controllable both in paying down and its desired outcome to increase her ROI (return of investment) percentage from 20% to 200%.
On top of that, she had funds for emergencies and additional money to invest on other opportunities that give better ROI than a savings plan. Doesn’t that make more financial sense? Amanda successfully leveraged her way for higher gains.
So, What is the Power of SMART Leveraging?
To simplify it, let’s say you have an objective to achieve, you know how to achieve it but all you need is something to leverage on to make it happen. A mortgage is a cost-effective way of borrowing. Interest rates on mortgage is no doubt the cheapest form of borrowing available in the market because it is secured with property.
What this is creating is that you are now boosting your wealth with effective returns. Just like the example of Amanda and John − Amanda has successfully increased her wealth by using only 10% of the asset value to give her a return of 200% after three years.
Worth a read : 3 Important Steps For Your Mortgage Application
Borrowing is Not New
We borrow to buy our homes. We borrow to buy cars, which is a depreciating asset but at times, a necessity. We also borrow to buy lifestyle indulgence goods.
Most of the time we borrow to do things that are not financially productive. SMART Leveraging can be incredibly productive when it is understood and used properly.
Therefore, equip yourself with the right financial knowledge and start using mortgages as a wealth creation tool. It can be used as arbitrage to leverage what you don’t have and yet benefit based on the total current value of the property when it appreciates over time.
The key here is;
A mortgage allows us to leverage and leverage allows us to do more with less.
About the Author
Gary Chua is the Chief Executive Officer of Smart Financing Co.
