How to use borrowing
to your advantage
Or why it’s better to own your home than
to pay $2,500 for a garden hose
Antonio is quite possibly the cheapest man on Earth.
The top drawer of his dresser is packed with almost every receipt he’s ever received. And, when something goes wrong, he’s right back at the store asking for a refund.
Case in point: in 1995, Antonio bought a garden hose that came with a lifetime guarantee. Sure enough, more than two decades later, when the hose had become brittle and cracked, he tossed it into the trunk of his car and headed for the hardware store.
“I’m sorry, that model has been discontinued,” was the reply. But Antonio insisted, and the store reluctantly gave him a full $20 refund. So now they’re even, right?
Well, not exactly. Antonio originally paid for the hose using his hardware store credit card. A credit card that charges 29% annual interest. Now, over the years, Antonio has bought many things on this credit card, and he has made many credit card payments.
But, because he has carried a bit of a balance on his card the whole time, it’s conceivable that he never really paid for that hose in the first place. In fact, if he carried that $20 balance at 29% interest for 20 years, he’d have paid about $2,524.84 for it.
Einstein himself made this observation:
“Compound interest is the eighth wonder of the world. He who understand it, earns it. He who doesn’t, pays it.”
So is debt bad? No. Far from it. When you use debt to buy an asset that rises in value, debt can be brilliant.
Consider this example:
Let’s say you put a $25,000 down payment on a house worth $500,000. Now, let’s say the house rises in value by 10% over the next couple of years. You’d make $50,000 after putting down only $25,000. That’s double your money! Borrowing to buy an asset that can rise in value – especially one with tax-free profits like your main residence – is just good financial planning.
Ok, so what happens if you’re like Antonio, carrying a balance on your credit card or line of credit month after month? If you own your home, you should seriously consider using the equity in your home to get rid of those debts. Apply for a new mortgage and just pay everything off.
Need more convincing? The minimum payment on a $5,000 credit card at 29% interest is about $170 per month, and you will spend more than $11,000 in interest by the time it is paid off. In contrast, if you used a variable rate mortgage with a rate of 2.25% to pay off your credit card, the monthly payment will be less than $22 and you will only spend about $1,500 in interest.
So mortgage debt has at least three good uses: it can help you enjoy homeownership, it can help you build your wealth over time, and it can help you free up your monthly cash flow by paying off your other debts, such as credit cards, lines of credit, and even car loans.
A good financial plan will take all of the above into account. In fact, for many people, the money they save by using their home equity to pay off their debts allows them to afford the other elements of their financial plan – such as monthly contributions to their investments and insurance.
And the best part is you don’t even need to save the receipt.