Understanding the fundamentals of borrowing
A cutting edge financial strategy will usually include debt. That’s because the use of debt can enable you to purchase assets that would normally be beyond your reach. However, too much debt invested in the wrong type of assets can be detrimental to creating wealth. Understanding the fundamentals of borrowing can help you avoid debt stress later on.
When you borrow money, you pay interest for having that money. Simply put, you end up paying back more than you borrow. That is not necessarily a bad thing. Ideally, the investment you make should earn you more money, through capital growth or yield.
The basics for a sound debt strategy look like this:
• Borrow for assets – Choose when to borrow and what to buy carefully. Borrowing for things that provide long-term increases in value such as property or shares should be a priority over things like holidays or new cars that have little or no long-term value.
• Affordability – Be sure you can afford the repayments. Understand what your personal cash flow position is and the impact the proposed debt will have on you and your lifestyle. Remember, it’s your responsibility to make repayments as per the loan contract.
• Regular Review – It makes sense to find out what else is available in the market so review your loan on a regular basis. Keep in mind that refinancing with another lender could release more equity, save you money or improve your cash flow.
While you don’t have to be an expert to borrow money you should at least use some common sense and develop responsible borrowing habits. We can break these habits down to four simple points:
• Never borrow what you cannot afford to repay based on your cash flow
• Prioritize your borrowing for assets that grow in value
• Maximise your borrowing capacity today to allow for rule changes tomorrow
• Always keep money in reserve for emergencies
The right mortgage is the one that suits your current situation. It should balance interest rate, term and maximum borrowing capacity so that you can achieve your goals. For example, it’s not generally advisable to give up maximum borrowing capacity chasing a low interest rate. Interest rates change regularly and the lowest one you find today may not be competitive tomorrow. Focusing on getting the most out of your personal situation allows you to maximise your ability to create wealth by purchasing assets of a higher value or perhaps even multiple assets. You can always look at interest rates during your regular reviews.
Borrowing money is a serious business and comes with much responsibility. You should thoroughly understand the commitment you are making and how it will affect your lifestyle. Spending some time thinking about what you want to achieve will make the process much easier.
Borrowing for the right reasons and living up to your repayment responsibilities can make borrowing a useful financial tool.
For a thorough review of your current borrowing arrangements, contact one of our brokers here