Borrow Your Way To Richness

In response to a reader’s question about generating working capital by borrowing (see the post “3 Simple Rules Behind Explosive Wealth Creation”), I would like to elaborate a bit on the reasoning behind getting rich via borrowing.

Before we jump into the glory details, let’s briefly go through an example.

Say, we want to borrow $100k from the bank for 3 months, we need to agree on returning the $100k together with the interest of X percent. The keyword is interest of X percent. No one will lend us anything unless there is a mutual agreement (loan) of a return on their investment.

In order to come to that agreement, the bank (borrower) will also research our credit history and assets to see if we are worthy of borrowing anything: our likelihood of returning the principal with the interest on time. Enough basics, let’s dive in.

In general, there are two kinds of borrowing, let’s label them good and evil.

The evil is taking the borrowed money and spending it onto something that generate us zero financial return. An example would be during the housing bubble, people who refinanced their houses spent all the proceeds on expensive cars, vacation, fine dining, or even gambling.

Don’t take me wrong though, we should reward ourselves with our hard work such as fine dining, and exotic vacations, but it should be coming from our hard earned money, not the borrowed money.

In some exceptional cases, investing borrowed money to entertain a prospect in business can help in closing a deal, but that’s a whole different topic that we can explore in another post.

Since borrowing involves interest, which is the cost of borrowing, we need to make sure that our borrowed money is invested into something that can generate a higher return than the interest we are paying. That’s what good borrowing is all about.

One exception is if we have reliable information that indicates the existing return on our investment will grow and eventually exceed the total interest we committed to paying upon the loan maturity. That is, with time, our investment increases in value at a faster pace than the interest (particularly floating rate) we are paying. This brings out the topic of time.

How long we should keep our loan outstanding?

The conventional wisdom is that we should pay off our debt as soon as possible. True if we spent the money with the credit card on living expenses or entertainment, not if the money is invested into acquiring income generating assets, and we can manage to keep the return consistently above the interest we are paying.

In the latter, we should keep this line of credit running as long as we can. This is particularly true in the prime real estate market. Talk to anyone who just paid off their house in NYC with a 30 year mortgage, and ask for their last mortgage payment and current house value, you will find out the power of time in an inflationary economy can do magic to your wealth.

To accumulate wealth fast, we need to leverage other people’s money. And people who lend us money are our investors. Our investors put their trust onto us and we should use their money productively to generate the return that we promised.

With time, we build up our reputation to expand our borrowing power, which will enable us to build up a healthy debt portfolio that generates positive cash flow for our investors and ourselves. Take this to heart and we can borrow our way to richness.

   

You may also be interested in the following:

  1. Middle Class Is For Suckers
  2. Cash Is King? Think Again!