We are constantly lured by advertisements promoting sales of discounted products; so it is natural we tend to seek the best price for anything we purchase. What’s more, there is a tendency to equate cheaper price to the best option. Naturally we carry this expectation with us when we go shopping for a home loan.

This is a mistake if you want to grow your wealth. Interest rates are an illusion. Rather than seeing rates as a cost that has to be reduced, see them for what they are: a side effect of getting as much as money as you can so you can create wealth for you and your family. After all it is the amount of money you have invested, not the interest rate you get, that allows you the opportunity to build your wealth.

Purchasing loans on interest rate alone actually plays to the bank. The bank makes money by lending at the lowest possible risk, so it’s best to know that they offer you an interest rate which they can get away with to achieve this. They advertise primarily on rate to attract new customers. They manage risk by setting credit guidelines, which can be manipulated to attract the right clients and to manage their exposure to the various markets. For example, if the lender feels risk in their exposure, a simple change in LVR (Loan Value Ratio) can drive a result. Banks can alter servicing calculators, increase living expenses, increase the weighting for existing debt and reclassify security types. These measures along with a myriad of others, have a direct influence on your ability to borrow.

By dictating what criteria customers must follow, banks limit our ability to invest using borrowed monies. Understanding bank limitation we can focus on what’s important, which really is the ability to obtain the money to buy and avoid placing emphasis on securing the lowest interest rate. While the interest rate may be important for a First Home Buyer, the smart investor needs a different focus.

An investor not only tries to maximise the amount they can borrow, they structure the loan so that they create a buffer for emergencies and a reserve for future opportunities. The idea is to protect oneself from sudden unexpected expenses as well as being ready to take advantage of any investment opportunities that may arise. Borrowed money is not for holidays, cars, or other personal expenses. It is directed solely creating wealth a larger and more robust portfolio which can eventually replace the need to work for money.

The more money in reserves, the safer investing becomes. The more reserves you have for an emergency, the easier one can sleep at night. The faster the renovation the less time without a tenant. The more money, the better a position to negotiate a purchase for example. Control is in the hands of the capital holder — not the bank — the lowest interest rate in the world is useless if one can’t get the amount of money needed to buy a property.

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This is contrary to what most people believe.

Once the bank has us as a client, and the more debt we have with a single lender, the more control they have. They decide how much money can be borrowed. The interest rate is an illusion as the banks don’t protect the interest rate, they protect the loan. At the mention of any client switching lenders, they drop rates to retain the client. So a key to securing a solid future when investing using debt is to borrow enough money, and to have a buffer for emergencies or a reserve for future investments. A reduced interest rate is less important in the big scheme of things as compared to having enough money so that we are open to opportunities and able to move our investment portfolio forward.

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Using mortgages to obtain value

At Finwell we propose that you consider your mortgage as being THE asset and not the item with which you secure your debt. It is a very different way to view things, but it makes sense once you understand what happens with capital that you borrow over time. Let us explain.

For example, buying a box of hot chips, say in 1985 would have cost 40 cents. Today the cost of buying hot chips would be remarkably higher – say $5. That is an almost 10-fold increase in price, or over 1000% increase, in 30+ years. It is not as if the hot chips are worth more today, but that the dollars used to buy them have fallen in value over time. Hence it can be said that the value of dollars is changing for the worse due to inflation.

Essentially, when the government prints money into our economy, the money used to buy goods becomes progressively less valuable over time. This is a trend, otherwise known as ‘inflation’. In the above example, as the price of chips increased with the money supply increase from 1985 to now, the price of just about everything else also increased. Our cars, our clothing, our bills, just about everything we could choose to consider increased markedly in price as money supply increased, without any great increase in value. With that in context, if someone had given us $10 in 1985, could we then keep it for 30+ years and have more purchasing power than we started with? NO we could not, in truth the $10 in 1985 would be worth more than $100 in purchasing power now if this were true, and it’s not. However, if we bought 10 X $1 pens at that time, the likely outcome would be $100 now. If we bought 10 newspapers, or $10 worth of lollies, or anything, the price would be what it is now – regardless of a change in value, the price rose on each item. Hence, money is becoming worth less over time.

Now consider a bank lending money to people. They borrow $100 and have to repay the amount in say 30 years. Consequently, the $100 at the time of the loan is worth an amount of goods, but 30 years later, it is worth significantly less – inflation is an invisible tax. Hence debt is less of a burden over time. With the continuation of an expansionary monetary policy, Australians continue to see more money printed into our economic system. This money (inflation) ends up on prices eventually. Inflation reflects in real estate assets as well. Inflation is a very important factor in the price appreciation of real estate. So with that, it is 100% fair to say that ‘money supply drives prices’ and also that ‘there is value in holding other people’s money, while governments are printing money more into our economy’.

Importantly, this premise does not necessarily align with any increase in value of the assets we hold. One must not be fooled into thinking that price growth is inevitable, nor is it simple to predict. For example, there have been times in the past where property asset prices have fallen over several years running. For example, from 1928-1930, there was over a 20% drop in residential property prices. However there is allot of merit in understanding the attribution of increased value, and not measuring just on price growth.

In summary, we at Finwell suggest you can use your assets to obtain value by borrowing against them — in other words taking a mortgage – and hence let inflation do it’s job for you. As always borrowing is to be done with a great understanding of the risks, and having appropriate risk management in place such as sufficient cash reserves to allow for significant fluctuations in interest rates, maintenance costs and income variations. With these things and the right choice of assets the future has greater potential to be a brighter one for sure.

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