Paying off debt vs investing further
How you can create wealth by understanding debt
I was in the Uber the other day and chatting with the driver as we headed to gold coast from a property seminar. As we were chatting, he was telling me how after living in Sydney for 30+ years he made the recent move to the Gold Coast.
He was able to buy a nice house along the water for half the price of what he sold his place down in Sydney for and was able to pocket the rest for savings into his retirement. As always, the conversation went towards how expensive it is in Sydney. He was glad that he paid off all of his debts and has been preaching to his children to do the same.
This is where I jumped in to add another opinion, what would happen if you had the opportunity to purchase three properties at the same spot instead of just the one 30 years ago? From a very basic mathematics calculation, he would have nearly tripled his wealth today. So if someone was able to help him work out the right property and finance strategies 30 years ago, he would probably still be living in Sydney (if he wanted to) but with a property for his children and selling or renting out the other to fund his retirement.
I grew up with the same mindset as him, as most of us do. Live life by buying a house and then pay it off over the next 30 years. If there is extra money, pay more of it off quickly and you might be able to own it in 20 years instead and save a bucket load of money on interest. While most people are comfortable with that idea, it really isn’t the way to build wealth.
Just look at the Uber driver’s situation 30 years ago.
Now let’s just change that to today and let’s work out the end wealth under two situations:
A – Buy a property for $500k, pay it off after 30 years with a capital growth rate of 7.2% p/a
B – Buy a property for $500k. Buy another one in 2 years for $500k and then a third one at the 4 year mark for $500k. All of them on interest only so we are not paying down any of the debt. Total of $1.5 million debt. Capital growth rate of 7.2% p/a.
Option A – Staying with one property, the net wealth would be the blue bar only which is about $4 million with no debt owing.
Option B – Purchasing three properties and allowing for time and compound growth, the total values of the properties are $10.5 million. Let’s remove the debt that hasn’t been paid at all of $1.5 million and we are still left with a net wealth position of $9 million.
Conclusion – That is a $5 million net difference in wealth!
There is a reason why investing in property is popular and why trying to pay down all of your debt doesn’t make much difference when you allow for time and compound growth. Build your asset base up as much as you can when you are younger so that you allow for time to do it’s magic.
Disclaimer: Keep in mind that there are a number of other factors that go into it such as capital gains tax, cashflow, personal circumstances, tax benefits, rent helping you to repay, maintenance fee’s, market changes, etc that will make it difficult or easier to continue with this strategy over the years.
Everyone’s situation will be different so feel free to reach out to us if you want an obligation free review to see if this can fit into your plans.