Neither a borrower nor a lender be...
This was a piece of advice my father gave to me, and his father gave to him, and has been handed down from parents since Shakespeare first penned Hamlet. While it was good advice back in the late 1500’s, in the modern age of commercial banks and tax write offs on interest, following it may be robbing some investors of far larger gains.
Let’s compare the purchase of a rental property, costing say €300,000 that an investor, who pays the top rate of taxes in Ireland, purchases for cash. For the sake of comparison, I’ll assume that they enjoy annual rent of 7% and capital appreciation of 3% annually, selling the property at the end of ten years. After paying all taxes (40% income tax, 4% PRSI and 8% USC on the rent plus 33% Capital Gains Tax on profits at point of sale) the investor enjoys an annual rate of return of 5.34%.
Mortgages and Loans, like all other financial products you care to mention, are simply “tools” and like regular tools, they can deliver huge benefits, but only in the hands of those really trained to use them. If, for example, you put me in a shed with a hammer and chisel, some nails and a lump of wood, in an hour’s time I’d have a couple of fingers missing and a bloody mess. However, put a carpenter in the same shed with the same tools, and an hour later you’ll have a place for your dog to sleep. The tools are the same, it is HOW they are used that dictates the outcome. The same is true for financial tools, used properly they can create fabulous outcomes, used poorly and all you get is a “bloody mess”.
Now, let’s apply a Bank Loan to the earlier example. This time our investor will invest their €300,000 separately and will borrow the money to purchase the property. The same rental yield and capital appreciation assumptions apply, but this time the annual return enjoyed after all taxes will be 9% +, an increase of close to 70%.
The principal benefits the borrower is enjoying is that they are getting an annual return on DOUBLE the capital, they are paying less annual tax as they are writing off their interest payments and they are getting a higher return on the investment than they are paying for the debt (I used an interest rate of 5%). In these circumstances, for those that wish to create wealth, following the ancient greed may well hamper efforts. Today, some of the richest corporations in the world are “lenders” and all the richest people in the world have created that wealth using, in one form or another, “other people’s money”, proof positive I suggest that being both a “lender” and a “borrower” is not necessarily to be avoided.