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I have always been rather reluctant to borrow. Some might laugh at me for not taking advantage of "good debt" but I believe all of us have different levels of tolerance for debt. It is almost like a religion. It is very personal.
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| Indecent? Lewd? Maybe, to some. |
Here is an email exchange with a reader on the issue:
Hi AK,
Love your thought process and your discipline and I was hoping you can give me your opinion.
Recently I have been toying with the idea of putting my name on my parent's property (1%) which will allow me to take a loan of up to 2 million based on my current income at a current interest rate of 1.4%.
The proceeds of the mortgage is purely for investment purposes. One reason for doing this, is that I am thinking of leaving my current job, meaning that the option for a "cheap loan" (i am not referring to the interest rate but rather a mortgage backed loan) for none property related investments. Apart from the risk of making poor investments and losing all your money while still owing the bank money blah blah, what are the risks that you see?
As background, I have 750k in various asset classes ranging from cash to shares to foreign property and no outstanding loan. Looking to retire in the next 5 years!
Happy if you want to share this as a post but don't put my name!
Cheers,
H
AK's reply:
Hi H,
Depending on your personal consumption level and the productiveness of your assets, $750K worth of assets could possibly provide a rather comfortable retirement income. So, I would question if there is actually a need to mortgage a fully paid up property to fund more investments.
This was something offered by my banker as well a few years ago. However, being very conservative when it comes to using debt, I chose not to do it. On hindsight, I could have made more money if I did it but I wonder if the feeling of unease which I am sure I would have had would be worth it. It is rather personal.
The question on the possible risks apart from the ones that you are already aware of is very wide. I definitely cannot see all the risks but if we are of the opinion that interest rates cannot possibly go lower, then, we must expect finance cost to rise. We might want to question whether the expected returns on our investments will be able to rise in tandem.
Also, we want to bear in mind that rising interest rates are not good for real estate owners, usually. The much higher asset prices today is mostly due to the abnormally low interest rate environment in recent years.
We could see real estate prices declining as interest rates rise. It would probably affect the valuation of your mortgage property and this, as you can imagine, could create an issue. Of course, depending on the property's characteristics, it could be affected more or less. It is hard to say for sure.
I will share our email exchange in my blog to see if others have thoughts to share. I will make sure not to include your name. ;)
Best wishes,
AK
We welcome other perspectives on the matter as well. So, please feel free to leave a comment.
Related posts:
1. Good debt is always good?
2. To rent or to buy: Rule of 15.
3. Gear up and receive more passive income?
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11 comments:
AK,
Hindsight is 20/20 vision.
If H had done it at 2009, 5 years later, he would have doubled or tripled his net worth.
However, if he had done the same thing just 2 years earlier in 2007, it would be tears and misery.
In the wise words of Clint Eastwood, "Do you feel lucky?"
HI,
I have been executing that strategy for the past few years and would like to share some thoughts on it. Like you, the loan was backed by fully-paid properties that are either co-owned or fully owned by my parents.
Cashflow Matching: How do you intend to cover the monthly payments ? If capital gains and dividends will be used to fund these payments, it's very important that you have a sound investment strategy and some cash buffer.
Refinancing: You would have to take into account government policies, interest rates, and the potential for a big drop in property prices (collateral) etc ... so, taking the right amount of leverage is crucial in the event of a recession.
It's also good to have an idea of how much you expect to make over the course of the leverage (eg. over 3 years). While it is impossible to predict market returns, having certain targets help you assess whether the risk-reward when leveraging is favourable. At the same time, be mindful of taking too much risk in the stock market.
Given all these risks, I think some leverage can be beneficial, provided there is a "game plan". Also, I would prefer leveraging on my property than buying shares on margin primarily because of lowers interest rates, more flexibility, and the likelihood of a margin call is lower.
Hope this helps :)
Hi SMOL,
Indeed so. I do enjoy a game of chance from time to time and I do believe that luck plays an important part in life. :)
There are things in life that I try not to lean on Lady Luck too much. To have a roof over my head that I have not only control but full ownership over is important to me. ;)
Hi Wei Jie,
Sounds like it has worked out well for you. Congratulations! :D
I believe you got in at the right time and, like I always say, entry price is important.
Thanks for sharing your experience and I am sure that H will take your advice to heart. :)
He needs to answer the million dollar question: How much would you pay to have a good night sleep?
Hi AK,
Thank you for sharing. Your blog is a great platform to exchange ideas.
Hi SMOL,
I actually I did more than double my net worth in years following the 2008 crash. I did so using my cash reserve, which was less than 40% of my portfolio at that time, to buy blue chips over the period of a year and left it there for between 3-5 years. I understand that leverage is a double edged sword and thus did not use margin or CFDs to gear more. Anyway, they did not suit my buy and forget style. Unfortunately at that time, I was uneducated about how I could cheaply leverage a fully paid up property at such low interest rate that was unaffected by the volatility risk of the stock market. Actually on hind sight, we would probably have been better off if we had just closed our eyes and bought a property or 2 in 2009. The automatic gearing of most property investment would probably have made that investment outperformed most blue chips in Singapore. Silly us... :(
Hi Wei Jie,
Great to hear from a person who has put such a strategy into action. I have actually been considering to do so for almost 2 years but after one of the cooling measures that required my name to be added into my parent's property in order to take a mortgage, I have been dragging my feet till now. Prior to this cooling measure, the mortgagee did not have to be an owner.
I agree cashflow a key risk to this strategy. My plan is that even if i see a very attractive opportunity, I must keep at least 1 year of mortgage payment as buffer in FDs or similar. For 1 million dollar loan and factoring for a interest hike to 3%, that buffer works out to be 45k. If the size of the loan is bigger, I will need to adjust the buffer accordingly
Regarding the risk that property prices falling and hence affecting the LTV, I feel that the mortgage should not be greater than 60% of the value of the property. That should allow the property price to fall more than 25% before there is any significant risks that the bank will ask for cash topups. Not sure is I missed anything on this?
Strategy wise, the loan will serve as a cash injection and pad my opportunity fund. Presently more than 80% of my funds are vested in non cash equivalents. I hope to bring my cash percentage closer to 60% or more. I am in no hurry to utilize the cash an am happy to pay the spread between the FD and mortgage interest rate for a few years (4-5 years) while waiting for that opportunity.
The way I see it, paying up to 1+% spread per year, while waiting for a opportunity that would yield 50-100% over 5 years is a good deal. In reality, I will probably apportion say 20% of the loan to safer yield instruments such as pref shares while keeping the other 80% in FDs. At about 4% yield, they should cover the spread between FD and mortgage interest.
Hi PF,
So far, I have never lost sleep over my investments (cross fingers :P). I am generally passive and typically long term. I don't believe in monitoring the market and I hardly trade. In the last five years, my total number of trades is probably total to less than 30.
Happy to hear more risks and pitfalls that I should consider from the gurus. I am worried that I have some massive blind spot.
Cheers,
H
On a side note, I wanted to hear everyone's thoughts as to why it is "taboo" to take a mortgage loan to invest in say shares but by comparison, a lot more acceptable to take a loan to buy a property as an investment.
Granted, a property is a lot less volatile compared to the stock market and is a lot less likely to become completely worthless. But I feel if you manage your risks correctly, you might not be looking at a much riskier proposition to invest the money in say shares for example.
In fact given the state of the property market, in some cases, it can be argued that it is less risky to take a mortgage to invest in low risk instruments instead.
To me by saying one should not release some equity from a fully paid property to invest is akin to saying one should not invest in anything else until one has fully paid up their property. Sounds more like emotion than logic :)
Don't flame me but I love to hear everyone's opinion
Hi H
I have the same thinking as you and would also like to know the thoughts of others here. Unfortunately I do not have a fully paid property to make use of yet so this is moot to me. But as AK alluded to, this strategy faces a potential "double whammy" of rising interest rates and Declining property price.
I think it's because property, when rented, provide the monthly monies for mortgage commitment. Share investing/dividend is less regular.. again, question of 'peace of mind'
Hi H
You are on the correct track. I learnt the same strategy from the late financial guru, Dennis Ng. His only condition for sharing his knowledge was that we remember to repay society by paying it forward.
Taking a mortgage loan off a fully paid property is a very safe strategy provided you have a game plan. The secret is to take the loan now and hold it as an opportunity fund. This is then mobilized when there is blood on the streets.
The cost of this opportunity fund is negligible when compared to the potential gain when investing near the market bottom.
Meanwhile, my opportunity fund is parked in FD which happens to pay a higher interest than the mortgage rate. While waiting for my funds to be deployed, I get to earn some money. What's there not to like?
Why not borrow after the market has crashed? Taking a bank loan is like trying to buy insurance. When you really need it, it is impossible to get. Try convincing a bank officer to give you a loan for investing when the bank is saddled with bad debt after a crash.
Feel free to share this information with friends and family and remember to contribute back to society.
Cheers!
If your req is to raise cash % from 20 to 60%, then just treat the mortgage loan as an option for you to get cash if you want, but need not execute it now just for the sake of seeing the numbers. That 40% is 700k which will incur unnecessary interest costs in my opinion. It really depends what you value in life too. If you value a peaceful sleep, stress free life and good relationships, you wouldn't want to create unnecessary stress by borrowing to invest. It's like gambling and if you start and strike it big (due to market cycles), there is a high chance to get hooked and the same market cycle might crash you out as well. You wouldn't know you are hooked and wouldn't know it's the market cycle by then and you will be overwhelmed by self belief because of the money.
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