Capital and its uses

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 a number 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 the 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 a lot 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 its 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 a greater potential to be a brighter one for sure.