This is why you should be in debt! - Live Your Life On Purpose
This is why you should be in debt Live


Now let’s talk about debt. How does the return on investment change with or without debt? In order to keep things simple, we will not take into consideration any rental-related operations but simply the gross rental returns vs. the total initial investment.

You have 265K in cash and you decide to pay for the full investment upfront without taking any loan — some may say to “reduce risk”. The following is what would happen:

Cash investment: $265,000

Cash reserves: $0

Yearly rentals: $33,000

Yearly return: 12,5%

Therefore, your upfront investment is 265K and your return on investment is 12,5% a year. This a very good return but you have no money left in the bank after the purchase.

You now decide that it is not worth to use all of your cash (good choice!) and you borrow 50% of the total investment cost from the bank. You do so by getting a loan for $132,500 over 15 years with an interest rate of 3%:

Cash investment: $132,500

Cash reserves: $132,500

Yearly rentals: $33,000

Yearly mortgage principal paid: $8,833

The yearly mortgage interest paid: $2,147

Yearly return: 23.3%

Because your initial cash investment is lower, the investment actually becomes less risky (should anything go wrong, you still have 132.5K in cash) AND your returns almost double!

Rental revenues stay the same at 33K, which is enough to pay back your principal and interest every year ($10,980 in total). When we look at the return, the loan principal is to be considered part of your return (since it is equity going in your pocket) while the loan interest must be deducted as it is a cost. This leaves you with a yearly return of $30,853 which equals to 23.3% of your initial 132.5K investment.

What happens if you decide to take on even more debt? You only put down 20% and borrow the remaining 80% from the bank. You do so by getting a loan for $212,000 over 15 years with an interest rate of 3%:

Cash investment: $53,000

Cash reserves: $212,000

Yearly rentals: $33,000

Yearly mortgage principal paid: $14,133

The yearly mortgage interest paid: $3,435

Yearly return: 55.8%

Now your initial cash investment is even lower and you have even more cash reserves on the side (notice how your risk does not increase as the full mortgage amount is again, backed by your cash reserves).

Rental revenues stay the same at 33K; this still enough to pay back your principal and interest every year ($17,568 in total). Deducting the mortgage interest from your yearly revenues, you have a yearly return of $29,565 which equals to 55.8% of your initial 53K investment.



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