Do you realise you're getting paid to borrow money?

By Michael Yardney

We’ve all heard the stories from elderly relatives, about how they bought their first home, a new motor car, and a three-piece lounge suite and still had change from $100.

OK, maybe $100 is a slight exaggeration – but it’s an inescapable fact of economics that one dollar today will not have the same purchasing power 10, 20 or 50 years down the track.

It’s called inflation, and while it won’t help you buy a can of Coke at 1985 prices, it could be your ticket to wealth through property investing.

It all comes down to the difference between good debt and bad debt.

Bad debt refers to consumer debts, for depreciating items such as vehicles, clothes and furniture – think your credit card, or car loan.

Good debt refers to funds borrowed against appreciating assets – this could be shares or a business, but is most likely to be in the form of property.

In times of high inflation, when you borrow money to fund an investment property, you are in effect getting paid for the privilege.

That’s because when you own income-producing property, inflation is your best insurance against the declining value of the dollar.

Thanks to inflation, long-term, fixed-rate debt attached to high-quality real estate allows you to pay back LESS in real terms than the original sum you borrowed.

Here’s how it works…

Imagine you purchased a property back in 1988 for $180,000 and that at that time a dollar actually was worth a full $1.

Thirty years later you find that same $1 only has 24 cents value in purchasing power, because of continued inflation driven by the government policy.

While the value of the dollar has decreased substantially over those 30 years, lets imagine you haven't paid down your mortgage.

This means your original debt is still $150,000, but you’re repaying it with cheaper and cheaper dollars as the years go by.

Although the overall purchasing power of the dollar has decreased over those 30 years due to inflation, the principal balance on your long-term debt is never adjusted in step with inflation.

By paying your mortgage, or eventually paying down your debt with continually cheaper dollars than those you originally borrowed with, you are effectively saving yourself a lot of money each and every year.

Now, think about it in today’s figures:

In 2018, you purchase a $1 million property with a mortgage of $800,000.

Let’s assume that over the course of one year you don’t pay down any principal, perhaps it’s , and there was a four per cent rate of inflation.

While the principal balance still remains at $800,000, this amount would now be worth only $768,000 in terms of real dollars.

That’s a reduction of $32,000 in one year!

That, right there, is how you get paid to borrow money.

Smart investors leverage this knowledge to inform their investment strategy and build their wealth.

If we assume that inflation will hover around the four per cent mark for the next 10 years, then in 2028 your original $800,000 loan would only be worth $531,886 in real dollars.

And when you consider that "real" inflation has actually been much higher than the commonly quoted ABS figures, your gains could be even greater.

That’s why now is a great time to own long-term debt tied to appreciating income-producing real estate – and let the magic of inflation reward you big time.

Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.

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