It's not every day that Money Maverick gets to write an impromptu article like the old days, where Financial Blogging was more of a Wild West thing.
But since I'm writing more articles outside of my specialty till the 19th, I thought I'd talk a little bit about something that was recently covered a few days ago:
Namely, Jamus Lim (Singapore's Golden Boy) and his debate with Parliament.
Many people are very focused on the minimum wage arguments, which I shan't really comment on - but I'm more concerned about the mortgage/remortgage debate, which was less prominently featured.
Mortgage Master did an excellent broad assessment here, and I thought I'd chip in briefly.
The concept of borrowing against your own asset, or other people's money in order to generate larger returns is NOT new - it's simply leverage and the potential for leveraged returns.
(You can read more about it in my Gift for FI-35, as listed below.)
And leverage, as we know, comes with risks. So why would Jamus Lim suggest it? SEE ALSO: Are 'Private Annuity' Plans Superior to CPF? – A Gift for FI-35 and a Lesson for Others
YES: Borrow Against Your Property/Term Loan unlocks Monies
Term Loans are a particularly favored idea for leverage amongst the ultra wealthy because the Wealthy often enjoy purchasing multiple properties.
More Importantly, a Term Loan is often one of the most favorable loans you can get from the bank. [Low interest.]
a) Favorable Loan (low interest): This is because the property serves as collateral. Add that to your history of having already fully paid off the property once, or any history with the bank - and it wouldn't be that surprising to get an interest rate well under 2%.
1-mth Sibor recently fell under 0.2%. Even with additional interest fees, that's an incredibly low interest rate that would be unlikely to surpass 1.5% in total.
As Jamus pointed out, interest rates are extremely low presently, one of the lowest points in Singapore's history.
By leveraging on a low interest rate to invest, you could potentially make a lot of additional money as long as you were able to outperform the low interest rate that you have to pay on your Term Loan.
b) High Range of Investable Options, High Arbitrage (Interest Difference:)
In Theory, assuming you are able to get an Interest Only Term Loan on a $1mil Private Property (full paid up) at 1% and you borrowed 75% of that value [$750,000] to do a 5% Bond...
Negative Interest in a Year: 1% = $7500
Positive Interest in a Year: 5% = $37,500
Passive Income Derived from Leveraging on your Own Asset: $37,500 - $7500 = $30,000/yr, or $2500/mth.
This doesn't prevent you from paying off your loan anytime, or renting your place for additional income. So in the above scenario, if you kept it sustainable - the arbitrage despite taking on debt would net you a lot of money for something that you already paid for.
Without this structure, you would miss out on that additional $30,000 a year as your money would simply be locked in.
(If that sounds like a familiar 'no money down' idea, its because it is, and works conditionally.)
NO: Going into Debt On Your Own Fully Paid Asset
Of course, it's reasonably hard for anyone to take on additional debt, especially if they've spent quite a decent chunk of their life paying it off.
There are some other potential caveats and complications, such as additional terms and conditions to your loan, loan limits, loan tenure limits - but most importantly, these two factors:
a) Amortization - the practice of paying debt through principal and interest at the same time.
Most Term Loans are rarely Interest-Only Loans, they usually require Amortization. If you've ever paid off a mortgage, you know that this has fairly serious consequences when you have to service the interest and capital of a loan simultaneously.
Take a look.
If you get a Term Loan of 2% (pretty high for a Term loan, but lets say it doesn't get higher than this) on a loan of $1,000,000 serviced across 20 years...thats $5059 you have to 'service' a month.
In a year, that's a total of $5059 x 12 = $60708.
Then you might have noticed something.
2% of $1,000,000 is $20,000.
$20,000 ISNT $60,708.
$60,708 is 6.07%, not 2%.
What happened? Amortization happened.
If I would like to invest my Term Loan into something like this and assuming a pretty challenging scenario - in order for me to make this loan worthwhile, I have to generate 6.07% or higher per year.
Compared to 2%, your options suddenly narrow down to higher interest instruments that typically carry higher risk.
b) Interest Risk
Which brings us to interest risk. As we know, interest fluctuates from the illustrations above.
Thanks to Amortization, if you get a unfavorable loan - you may have to service your capital and interest out of your own pocket for a seemingly low interest rate.
The upside to that is of course - that you would have both your loan capital and your property paid off in 20 years if you do this effectively. (Property + $1,000,000). Or the downside - where you fail to generate that yield and have to service more out of your own pocket.
Conclusion
Some of these ideas are typically explored by the wealthy, or even the middle class who own more than one property. It is reasonable to explore options to create additional income, especially when assets are seemingly trapped. While Robert Kiyosaki may not be the best role model, I'd definitely prefer assets that put money in my pocket.
Jamus spent a considerable bit of time clarifying his stance.
Likewise, if you would like to pursue an option like this, do seek an investment specialist like myself who can clarify - and carry you through the calculation of risks and make comfortable decisions for your future benefit.
Money Maverick
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