Whilst it\u2019s possible yet difficult to save your way to a property deposit, it\u2019s almost impossible to save your way to a comfortable retirement.<\/strong> If you attempt to save a lump sum for an outright property purchase, you might only buy one or if you\u2019re lucky two homes over the course of your entire life.<\/p>\n You simply can\u2019t save money fast enough on an average income to keep up with the growth in property prices in most capital cities.<\/p>\n Enter leverage.<\/p>\n The whole aim of leverage is to borrow other people\u2019s money to control a larger asset and enjoy the investment returns you make from controlling that much bigger asset.<\/p>\n Say you\u2019ve got $100,000 in cash, and it will return 10% per annum.<\/p>\n In one year, your investment is worth $110,000 and you\u2019ve earned a $10,000 profit.<\/p>\n You also have no debt, so all that profit is yours.<\/p>\n Leverage allows you to borrow money<\/a> to earn a return. Picture: realestate.com.au<\/p>\n<\/div>\n What if you took that same $100,000 and borrowed $400,000 to buy a property worth $500,000?<\/p>\n Let\u2019s assume the same 10% return, but this time you\u2019re paying 5% interest on the borrowed money.<\/p>\n After a year, the property is now worth $550,000.\u00a0 So, you\u2019ve made $50,000 whilst paying $20,000 in interest.\u00a0 But, you\u2019re still $30,000 in front.<\/p>\n Using leverage, you\u2019ve increased your total return three-fold from $10,000 to $30,000.\u00a0 You\u2019re building wealth three times faster than if you hadn\u2019t borrowed money at all.<\/p>\n That\u2019s the power of leverage.<\/p>\n But remember, for leverage to work, the expected capital return must always be higher than the interest rate on the borrowings.<\/p>\n As your investment is growing quickly, you\u2019ll be able to use the\u00a0equity that you\u2019ve earned in the initial investment much sooner to buy a subsequent property.<\/p>\n For example, if you need another $100,000 to buy a second investment property, it would take 10 years of earnings under example one, but just three and a half years under example two.<\/p>\n As long as you can afford to service the debt, you\u2019ll build wealth substantially faster than if you didn\u2019t use leverage.<\/p>\n Your money is working harder for you\u00a0because it\u2019s controlling a much bigger asset.<\/p>\n Yes, you\u2019re paying interest with leverage but the bigger asset will generally return more rental income<\/a> as well.<\/p>\n Debt isn\u2019t always a bad thing. Picture: realestate.com.au<\/p>\n<\/div>\n So, what about the fear of debt?<\/p>\n Most people have been taught that all debt is bad.<\/p>\n But we think that debt is misunderstood and knowing the three types of debt will help break down the fear.<\/p>\n Going into debt to fund the purchase of something that decreases in value isn\u2019t a great idea. Picture: realestate.com.au<\/p>\n<\/div>\n You use horrible debt<\/strong> to buy anything that goes down in value.<\/p>\n Examples of this kind of debt include personal loans<\/a>, credit cards, and store cards.<\/p>\n You should steer clear of accumulating this type of debt.<\/p>\n It\u2019s absolutely fine to have a nice car and fashionable clothes, but save up and pay with cash, rather than financing<\/a> these purchases by going into debt.<\/p>\n The debt from a mortgage<\/a> is an example of a tolerable debt. Picture: realestate.com.au<\/p>\n<\/div>\n Think of the tolerable debt<\/strong> used to buy a\u00a0family home.<\/p>\n It keeps a roof over your head, but it\u2019s not making you any money.<\/p>\n The reason it\u2019s tolerable is, whilst your property might be going up in value, you\u2019re typically the only one paying for it.<\/p>\n Going into debt to fund a long-term investment that earns money is productive. Picture: realestate.com.au<\/p>\n<\/div>\n Sensibly embrace productive debt<\/strong> to buy income-producing assets that are likely to grow in value.<\/p>\n Ideally, we\u2019d all have zero debt, pay no interest at all and have mountains of cash to buy investments outright. \u00a0But that\u2019s just not realistic for most Australians.<\/p>\n The beauty of the productive debt on an investment property is you\u2019re not servicing the debt alone.<\/p>\n The main difference between tolerable and productive debt relates to who pays the interest.<\/p>\n In a productive debt situation, it\u2019s the rental income or tax concessions that will contribute\u00a0the most to paying off the interest.<\/p>\n So you\u2019re contributing a much smaller amount to service that mortgage than with a tolerable debt situation.<\/p>\n With a tolerable debt,\u00a0you pay it all.<\/p>\n So, making friends with productive debt may well be the key to financing a comfortable retirement.<\/p>\n
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<\/strong><\/p>\nExample 1: No debt or leverage<\/h2>\n
Example 2:\u00a0 Using debt and leverage<\/h2>\n
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<\/p>\nThree types of debt<\/h2>\n
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<\/p>\n1. Horrible debt<\/h2>\n
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<\/p>\n2. Tolerable debt<\/h2>\n
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<\/p>\n3. Productive debt<\/h2>\n
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<\/p>\nFor more from the Property Couch, visit\u00a0thepropertycouch.com.au\u00a0or subscribe to the Property Couch podcast, available on iTunes or Android.<\/strong><\/em><\/h6>\n
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Realestate.com.au <\/a><\/p>\n","protected":false},"excerpt":{"rendered":"