In the first episode of this series, Ryan and Terry explained why debt is so important for growing your money. In this episode, they explore the different ways debt can be used to build wealth.
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In the first episode of this series, Ryan and Terry explained why debt is so important for growing your money. In this episode, they explore the different ways debt can be used to build wealth.
Expect to learn:
Join the Private Podcast Community
Click here to access free courses and trainings, build new habits, and connect with us and others on the journey to financial self reliance.
Other links 👇
Money mentorship:
Click here to start putting what you've been learning into practice.
Corporate program:
Click here to find out more about our workplace program
Follow us on Instagram:
Click here to see behind the scenes of our business and learn more about personal finance in bite-sized chunks.
Welcome back to the show. This is Terry. I'm here with Ryan. This, I reckon, is probably going to be one of your most favorite episodes. If the last episode wasn't your favorite, I reckon this one might be the next favorite, because it's almost like we're about to go into the toy shop and I'm going to show you all the toys. But what are we going to be talking about in this episode with that debt series?
Speaker 2:I love it, matt.
Speaker 2:Yeah, we're going to be talking about the four ways you can use debt to build your wealth, and the reason why we're doing that is because, if you think about all the options, you'd be more likely to use debt in a way that works for you, and I know we laid this up a lot in the last episode, the last two episodes really, in kind of doing that deep dive on, I guess, the system and working with the system and making sure that the system's on our side, and so this is basically how you do unpack that and figure out well what tools exist and how do you actually do that, and we want to make sure that we're avoiding taking on the wrong kinds of debt and we're making better decisions about the amount of debt.
Speaker 2:But, importantly, make sure we can stay in the game long enough to see the rewards, because a big part of this is making sure you stay in it for long enough to see things compounds and see those things actually come to fruition. As we know, everything short term has its fluctuations and your cycles and all of those things, and so, when it comes to debt, all those things are amplified a little bit, and so we just want to make sure that we are doing that in a way that lets us see it out, let's us see it for long enough to see those rewards.
Speaker 1:I'm picturing like standing in front of a ride at a theme park and going, hey, this looks pretty hairy, but really you just understanding that, like every time it runs, people are coming back to the start again and they're jumping off and they're just fine. You just need to be able to see that. Actually, it looks like you can hear a lot of screams, you hear a lot of drama and all those same people get to the end of their all happy and smiley at the end. Pretty accurate. So what specifically are we going to talk about in this episode?
Speaker 2:Yeah, so in this app, we're going to look at the different types of debt literally the different products that exist for us to use in Australia and then we'll be able to look at the two most common ways that is used this debt is used that most people will be aware of, but maybe don't understand to the full extent but also the two less common ways that maybe you haven't thought about. So we're going to unpack that a little bit as well. And then, lastly, how you actually improve your borrowing power. So how do you figure out how to draw more of that future savings into now and buy better prices? Like we talked in that last episode, we want to benefit from inflation, knowing that that's inherent in our system, in our financial system, and so it's how we see what options exist to help us do more of that.
Speaker 1:Essentially, and that last part is actually probably more important now than almost ever, because those who have borrowing power now are those who are getting very good deals, isn't it, yeah? And so, yeah, we're going to be talking through what are the most important parts of that equation, because I think a lot of people have this misconception that it's all just like, well, it's how much my deposit is right, it's how much money I actually have, and it's just not the whole story. So we're going to go into that in a bit more depth, so you know what levers you can pull if you are trying to improve your borrowing power, to be able to use this weapon of debt and wield it to build your wealth.
Speaker 2:And to that point, it's not just about how well you present yourself and the things like that the deposit and savings. There's also the assets that you're choosing to buy and how that plays into how much you use. So we're going to really look at what actual assets exist and how they interact with debt ultimately and how they influence the amount of debt that you're able to use, and so by the end of this set, you'll have a much more nuanced understanding of debt than most, I would say, and have better questions to ask. You broke it to. So whoever you're working with, that helps set you up. In this way, you'll be able to ask some really good, pointed questions and get some really good answers as well. So key to dig in man, all right well, let's jump in with the first part.
Speaker 1:We talked about the different types of debt, so I think this is really important to cover first, just so we can get an understanding of like people will just say debt is bad or debt is good. That's really not the truth. There's some color in between that. So let's actually tease that out. What's the first type of debt, mate?
Speaker 2:So the first type of debt is consumer debt and it's most likely used to buy things that cost you money. You know it's going to be a credit card or it's a car loan. You know buying clothes, buying cars, buying what else do you buy with credit cards? Generally things that don't really do that much for you, shiny trinkets, something that you probably won't have in five to 10 years time, I would say it's something that's probably not long lasting and so you're taking on that debt.
Speaker 2:You're buying something that's going to disappear in some time and obviously you need to pay that back, but it's not going to be something that grows in value or earns you an income. So that's the first type of debt and obviously that's just an expense that you start to carry. And, like you said, there's three types of debt. So the second type of debt is what we call a hybrid debt, which is really focusing on your mortgage, the home, the debt that's helping you buy your home. And we call this one dimensional debt because it's helping you buy an asset that can grow in value and when it does grow in value, it helps create equity in your home that you can use as a lever to help you essentially buy the future assets that you're looking to buy. So if you're looking to buy investment property or shares, something like that, you can use the home as a way to get you closer to buying more of those sooner.
Speaker 2:Obviously, we call it one dimensional in terms of thinking about the two dimensions of an asset, so income and growth. One dimensional because the home doesn't give you an income. Obviously it's more of an expense and it's a pretty decent line item in the monthly wallet. I don't know how much is it for you, terry. You might know it's pushing five grand now, matt, is it?
Speaker 1:Yeah, 1% of the wallet's up and around. It's available on how we do each month. It's going anywhere between sort of high 20s up to 40%, depending on how we do each month. So 40% does sting a little bit, I'll have to say.
Speaker 1:But the other side of this, though, is you said that it's a useful side of things. So you can say cost of living is going up and we're all sort of battling and that sort of thing, but we've got the home revalued the other day, and in the space of 18 months, the home's appreciation and value has far exceeded what we could have saved. You can feel like, oh, the things are getting really, really harder, but your actual net position is changing in a positive way, and you're just not aware of it because it's not the concrete number in the bank account. So if you're not actually keeping a track of that, and that deed actually helped, we feel a lot better. I'm like you know what? We have sort of struggled a bit here. We've sort of worked pretty hard. At times it's been a little bit tight, but if we look at it it's totally been worth it, yeah, and you would have bought that house eventually.
Speaker 2:So if you had waited 12 to 18 months, let's say, to buy the home, then you would have had to spend an extra 50 grand, right? So it's like, whether or not you saved that money or you didn't, it actually could have cost you if you waited. Right, that's right. It just makes this.
Speaker 1:The savings are just working, whether you kind of know it or not. So, like you're still saving, it's just the way that you'll save is changed. And that's where I think you know being on the other side of this and fence of the mortgage yes, yes, you're going to take out this kind of debt. But I think a lot of people go, oh, it's just massive. And I'm like, well, you know, I'm really appreciating it for what it actually is. It is making your savings work harder.
Speaker 1:You are being able to sort of handle that problem to the bank in some sense and benefit from inflation, but at the same time you actually get the utility of owning the home. You get to have the place you want. No landlord's going to come put the rent up on you Obviously rates could go up, but you get to have it. However, you want to set up the place, be a lot more secure, and I know that renting has been really really tough over this last 18 months, getting the right kind of place. We know people that have actually gone to court because they feel they've been discriminated against by people who haven't even given them a look in for a kind of home that they want to rent so you don't have to deal with that problem as well. So I think the utility side of owning your own home is very underplayed by people who are, you know, just very anti-dead.
Speaker 2:To be honest, like for me personally, I was a bit of a disciple of Peter Thornhill, having worked in a business where he had a very close personal relationship, and he influenced me on this quite a bit early days and it probably came out, probably in the early parts of our podcast, I would imagine, in that, you know, I always thought it was a fantastic idea to say we'll build up a base of investments 50 grand, 100 grand, whatever it might be and then own the home, which we did do.
Speaker 2:But we've actually reached this point in time where, because the price of houses are growing so much, if it's something that you want to do, eventually waiting to buy that home versus buying it sooner could actually work against you. With the amount of asset inflation we've seen over the last 10, 15 years, and if that does continue, then it may actually be that you can build the investment base that you want your portfolio at a quicker rate by buying the home first and then having it create some equity, so that you're not having to pay for more later but also seeing the growth in that asset in that home create equity sooner. That allows you to borrow against the buyer more assets and so, interestingly, like it's not as black and white as I guess we used to like to think it was. It probably was right because the amount of inflation, the amount of new money was getting created, wasn't as bad as what it is right now. So it is also something that can become quite a neighbor for making bigger money moves if you know how to use it.
Speaker 1:The other side of this, too, is that it is a forcing function, so you could say the timing of this oh, that's actually a bad time to buy a house. The timing in terms of life and life cycle is the other piece of the puzzle that we talked about. This is really important because there are times that you really want to sort of lock in focus. That pressure that it creates is actually a good thing, because it causes you to focus, it causes you to be more productive because of it. There's this whole concept of Yerks and Dodson's law, where it's like well, if you're under stimulated, then you don't really find the best of yourself. You want to actually calibrate pressure in a way that actually makes you go. I need to get going. I need to figure out a new way to solve this problem. I need to do it better.
Speaker 1:So for me, actually having the mortgage has been fantastic and the growth of the business has actually correlated pretty closely with the actual getting of the mortgage, and I don't think that's a mistake. I think that's not a coincidence, because you've got more. You've got a bigger purpose, you've got more obligations you kind of want to take care of and, as rates have risen same thing. You just kind of think harder and harder about how you keep adding more and more value to be able to offset it, and that's exactly what's happened. So, even though rates have gone up, there have been times where it's actually we've saved more because we've made the business work harder. That's not a mistake. Those two things are pretty well linked, I reckon For sure.
Speaker 2:And I think that Yerkson Dodson's Law is actually worth having a bit of a Google and having a look at, because it shows you that bell curve of being under stimulate or under, you know, having low amounts of pressure versus too much pressure. And then this happy medium, and I think so many people are trying to get this point of comfort of being like I want to have as little stress or pressure in my life as possible, and then they usually get there and go oh shit, geez, I feel unstimulated. I actually feel like I want to build some more pressure into the way that I'm living, and so it is an interesting model to think about.
Speaker 1:And a lot of it comes down to just choice, right? So if you feel like you've been sort of shunted into this and you didn't feel like you didn't choose it, then your experience, the way you experience that pressure, is so different internally, then you're going consciously. It's now time for us to put ourselves in some pressure. We want to grow, we want to actualize, we want to move to the next stage of our lives. We want to make this happen, and the way you frame that decision is very important with how you actually experience it. So if you do understand that debt is a weapon, debt is a tool that you can use to really accelerate your savings of this period of your life, then you don't have to go through the next five to 10 years going, oh, this whole debt thing, such a burden. You can actually look at it and go because of that. We get to do this and we're going to get to do more of these things over time.
Speaker 2:Yeah, quickly to call out, like if debt didn't exist, you probably wouldn't be living in the house that you're living in right now. It's the thing that's allowing you to do it now instead of in 20 years time, and so it's reversing it, saying, well, instead of saving over 20 years to then be able to build and buy that home or whatever that is, I would say you can have it now, but then you're going to have to make the repayments over time. It's also like a time factor. It's like how much time do you actually get to enjoy the things that you want to have, and so that kind of gets underappreciated as well, definitely.
Speaker 1:Let's move on here, mate. We've talked about type one, consumer debt, which is shitty. That is bad debt. Then we've got hybrid debt. We've just talked about the mortgage here and how it's not all bad. There's actually some good parts to it. There's a third type of debt. Here, too, can you take us through that?
Speaker 2:Yep, absolutely so. The third type of debt is investment debt, and there's a couple of key important considerations with this. A lot of the time with debt, you do assume that you have to pay that interest, but you also have to set up a repayment plan, which is the principle of the loan, which is like the amount of money that you've actually borrowed. So if you've gone to the bank and said, hey, can I have 100 grand? And they give you 100 grand, they will want to set up what's called an amortization schedule, which is basically just this mathematical table that says for you to pay this back in 10 years to cover the interest and actually repaying that principal balance back to us. This is how much you need to repay to us every single month, and at the 10 year mark it's going to be fully repaid, it's going to be gone, and so that's where you're looking at a loan. That's principal and interest, and typically you know if you've got a mortgage, then it's likely that you've got this set up in this way and it's the most common form, if you like. But there is also the option to have it on interest only, which is, instead of paying back the principal amount, the amount you borrowed from that bank the 100 grand, for example you can just pay the interest and not pay back the principal.
Speaker 2:You might remember the last episode I talked about the fact that the bank doesn't actually want that money back. Like, their asset is the loan that they have with you, and so they're trying to give out as much money as possible because that's how they earn all their income and get the juicy profits that they do. And so if you're going into interest only, they don't look at that as a bad thing necessarily, but they don't always offer it. You know it is something that you usually have to ask for. They don't just say, hey, do you want to as principal interest or interest, only usually have to say, hey, I just want to pay the interest so that you know I can direct the other money somewhere else, which often makes sense, and that is the reason why you would want interest only right, so you can free up your cash flow to be able to prioritize other things.
Speaker 1:That's the real reason.
Speaker 2:Yep.
Speaker 2:Also, if you've got those three types of debt, then usually the last one you want to pay back is that third type.
Speaker 2:So if you've got that type one debt, which is the consumer debt, you want to prioritize with the savings that you've got that you can put towards paying down debt you want to put it towards that it's going to be the most expensive but it's also not helping you buy an asset that does anything of value then you want to pay down the type two debt, the hybrid debt, which is your mortgage, because for those first two types of debt you don't get any tax deductions and not helping you buy assets and earn an income. That's a really important thing to probably understand as well, which is, if you're borrowing money and it's helping you buy something that's going to earn an income there's a link between those two then the interest on that debt becomes tax deductible. So if you're earning a hundred grand, you've got 10,000 in interest for an investment loan, then you don't pay tax on $100,000 in income, you pay tax on 90,000. It brings down what your assessable income is.
Speaker 1:This is a really important point, isn't it? Because that's where the whole nuance of like debt is bad is completely missing this point, because if you're a very high income earner, then you are definitely looking for ways to offset how much debt you're going to have to pay because of your high income. And if you can use debt to buy and own a bigger capital base sooner, then it makes fantastic sense for you to use a vehicle like that to be able to reduce your tax obligation and or maximize your prospects over time as well. And so that's where it's such a gangster move and the whole debt is bad thing. You just completely misses that right. This is the g code, really.
Speaker 2:Yeah, this is why we're going to the nuance of this. Some debt is bad and you should absolutely in type one and type two, absolutely probably should get rid of as soon as you possibly can, because they're expenses. If you look in your budget for the month, those two are going to take up some space and as soon as you get rid of them, what your life looks like on a weekly, monthly basis, it feels a lot more freeing when they're gone. The investment debt's a little bit different though that type three debt, because you're earning income from the assets that it's helping you buy and that income is covering the cost of that loan. So it's not a monthly expense that you're dealing with. We'll talk about like timing, a cash flows and stuff like that too, in a minute.
Speaker 2:But you don't have to look at that debt and go. That's a burden on me. I'm burden on my cash flow as such because it can actually sit separate, you know, even from your banking ecosystem. We actually, with our clients, we have it set up at separate from it all and it's not something you see every single month. It's things you might have to contribute if you need to supplement it, or it might just be something that shoots them stuff across over and into your income, but it doesn't need to be something that you look at and go. This is costing me, essentially like the other two are.
Speaker 1:Definitely All right. So that's the three types of debt. We've got consumer debt, hybrid debt, which is one-dimensional growth only, and then we've got investment debt, which is two-dimensional growth and income, and obviously we're trying to eliminate number one, minimize or get rid of number two as quick as we possibly can to maximize number three if possible. Let's jump into the next part, which is the common ways that debt is used to be able to get more of this investment debt. There's two here that most people know about that we want to jump into, but there's two that less people think about that are actually quite great opportunities in and of themselves. So let's do the first two, which is what most people would actually be aware of or sort of understand, before we jump into the second two. So what's the first one, mate? The?
Speaker 2:first one is to buy investment properties. So if you've bought your home, or maybe even haven't even bought your home, you're looking to do something like rent-vesting. Usually, if you bought your home, then it's like what do I do next? And often that comes in the way of creating some equity in your home, which is paying down the mortgage and having some appreciation in the value of your home, and creating this space between what the house is worth and what you owe against it. And if you think about you know the home, you can break into a few sections, but essentially there's a gap that gets created between the 80% of the value of that house and what the loan is against it, and the bank says you can borrow money secured against that part. That equity is what you call that to help you buy something else. And so a really common one there is to buy a second home, to buy an investment property.
Speaker 2:The second one is to buy shares, and you probably heard about debt recycling. I know we did an episode around this before and we might even drop in the show notes at the end of this as well, a link to a guide on how this actually works, but it's essentially the same thing, you know, having that equity that gets created in the home by making those principal and interest repayments, but also seeing the value of the house change and go up over time. And it's setting up an investment loan against the home to buy shares with that money and then use the dividends from those shares to service the loan. And so in both instances there are ways of that house becoming an enabler in terms of buying other assets and often buying bigger lump sums. Right, you might do that with.
Speaker 2:You know, if you're going to buy an investment property, it might be releasing 100,000 in equity as an loan to help you buy another property, and that property might be worth 700,000. And so you've actually increased your asset base by around 800,000, but also taking our loan of 800,000 to do so. Shares a little bit the same. We don't tend to see people be quite as aggressive as that with shares. It's probably people tend to reserve a little bit more so there. And it might be that you create that 100,000 in equity and buy $100,000 worth of shares and so you only increase your asset base by 100,000 as opposed to 800,000, like you do with the property, and so you can start to see where the assets themselves play a part in how aggressive you're using debt in all of this.
Speaker 1:That's where that return on equity ratio is pretty interesting, isn't it? Yeah, you think about the equity you're actually using and the return based on an $800,000 asset base. You just know, like intuitively, that you're going to get a higher return on equity by getting a bigger base, basically. So if you want to make your money work harder, those two different choices are there to you. One of them allows you diversification, but it limits your asset base, and the other one concentrates you a little bit in one asset class, but your ability to own a greater capital based. Sooner, like you said before, pull it forward, sooner You're going to get to benefit from that over the passing of time, more so than the other one, because more money in the market sooner works harder, doesn't it?
Speaker 2:Yeah, If you look at COVID as an example massive amounts of stimulus that got pumped into the system. The people that were rewarded most from that were relatively the people that have borrowed a lot to buy and had a bigger asset base as a result of it, Because when you've got more debt to help you buy more assets, when more money gets created, the asset base goes up. The debt does not, and so it has this depreciating effect, if you like, in relative terms of the debt itself, and so it's a big factor for sure. And it's actually where it's not one or the other. Often it's one and the other, Sometimes it's one then the other in terms of those assets that you're choosing at different points in time.
Speaker 1:What would be the case for unlocking equity to buy shares first and then going into property, and then the inverse? What would be the case for unlocking equity to buy property first and then shares Like? In what circumstances do you think that would make sense, both those sequences?
Speaker 2:If cash flow was tight, you would most likely release to buy shares first, because the likelihood of actually covering the cost of the loan from your shares is much higher. If you had lots of cash flow and interest rates were okay and supported it, then you would probably go down the realm of saying I want to buy the next investment property, because then you've got to be your assets creating equity that can still be used to create equity to loan against to buy the shares. So it really depends on a cash flow position and your appetite for having more concentration in your asset base. And look, right now it's quite tough to buy an investment property because interest rates are quite high. Not many properties are actually cash flow positive, especially if banks are making you be principal and interest repayments. And this is the generally thing about.
Speaker 2:When you buy your home or the first assets you're buying, you use cash to help you buy it. You put down a deposit or you invest an X amount of money. But that's kind of the last time you do that. If you're optimizing from a tax perspective and from a debt perspective, it's actually the last time you do it. You're basically dealing equity from there on out because, like we talked about in those three types of debt. If you are prioritizing repayment on those first loans and then you've got investment loans, you'll actually want to channel as much as you can towards either the consumer debt or the mortgage, for example, meaning that you're creating equity in your home and then you're borrowing the whole amount to buy the next asset. So if you're buying an $800,000 home investment property, you're borrowing that whole $800,000. And the chance of an $800,000 asset against an $800,000 home being cash flow positive, your rates have got to be relatively low. So it's 6, 6.5% right now. It's pretty rare If it comes down to 3%.
Speaker 1:That changes quite a bit, and there's probably just one point to make here. I'm pretty sure they're still doing this, but they test at 3 percentage points above the current rate for your we'll talk about this more later but your service ability and that's actually the big restrictor right now, isn't it? Because they're testing against like 9%, 10% rates for a lot of people, which is just frankly not doable for anyone, and that's even people that are on very, very high incomes.
Speaker 2:Yeah, yeah. So they have to look at and go from a risk perspective. If rates increase by another 3%, could you manage that loan and that's what they assess it on and for a lot, especially when you've already got a mortgage. You then have to supplement a negatively geared property, which is the repayments are higher than the rentaling come. You're earning from it pretty limiting at the moment.
Speaker 1:But if you can do it, then you've got no competition. There's not much competition for you and you can get into some good asset if you can find them. But yeah, that makes sense in terms of the two different common ways. Debt is used to buy investment properties and also to buy shares, and it sounds like as well as you've said that you really need to think about cash flow and the timing of when that kind of cash flow hits, whether you can actually deal with that.
Speaker 1:Shares might be something that works better for you because the yield or the income from shares is higher and it can basically wipe its own face and look after itself, not create any additional pressure on you on a monthly basis, whereas when it comes to investment property, there are times where potentially you actually could be having to fund the shortfall that comes up. So they're the two big sort of considerations. The trade off is one of them gives you a bigger asset base for longer. One of them gives you a smaller asset base, so your opportunities to grow your purchasing power are a bit more limited with the shares one. But better than nothing, isn't it?
Speaker 2:Yep, but also depending on your cash flow, like if you're saving heaps, you can absorb a lot more than it might make sense to go for the beer. If it's a little bit tighter, that might make sense to go for the smaller. And again, it's about the mix of those two and obviously that those two I think we just explored the role that the home plays in helping you still buy those using equity, those two assets same thing, different types of debt. You can take out just a standard investment loan to help you buy an investment property, like you would buy the home to buy shares. You've got margin loan, which you might have heard of before, which is essentially, if you buy $100,000 worth of shares, you can take out a margin loan for $100,000 and it's secured against the shares themselves. So like your mortgage, secured against your home. So the bank says if you can't pay it back, then we have security on the home. We can take it. Same thing there, where you've got the loan secured against the shares.
Speaker 2:Trouble with margin loan is and we saw pretty heavily with the global financial crisis is if the value of your shares fall quite dramatically, then you get what's called a margin call, which is the bank says hey, the value of your shares relative to how much you've got loaned against them is too small. We want you to pay down your debt. We want to pay down that loan. And that's usually at the worst possible time because it means that markets fallen and usually people get squeezed and say, if you don't have cash in the bank to be able to do it, you have to sell those shares at the worst possible time to then pay down that loan. Would you want to avoid at all costs? It sounds like a shitty deal, to be honest, like I don't really like it. No, it's a shitty deal.
Speaker 2:Yeah, there's something I'd probably recommend either, to be honest. Yeah, there is a new mechanism, something that I do use personally, which is an equity builder, so specific product that NAB in Australia offers called an equity builder, that actually acts more like a principal and interest home loan, but for the share portfolio. So instead of being like that margin call if the value changes, there's mechanisms that can you know they have to call upon that money. Instead, you can actually secure a loan against your portfolio and borrow to a much higher rate, comfortably up to 80% if you like and instead of the value of those shares having an impact on the loan itself. You can just make principal and interest repayments and say, well, over the next 15 years I'll make these repayments and the price of the shares is irrelevant, which means that you can stay through it, especially if you know prices fall and stuff like that through those market cycles. So you just kind of cut away that risk.
Speaker 1:It feels to me like that one. It's sort of feels similar to a home loan, where it's like look, we're not going to kick you out of your house if the market takes or something goes wrong. Like you can keep your house, you just got to keep making sure you make your repayments. So it's kind of like that nice medium, isn't it?
Speaker 2:Yeah, as long as you can make the repayments, basically they're happy, Whereas the margin loan not so much. It's a bit more risky on that front, Much better deal.
Speaker 1:Cool, all right, so that's the two most common ways that debt can be used the investment kind of debt, the good kind of debt.
Speaker 1:Let's talk about the two less common ways. We discussed this when we set out this episode. We said like it feels like a pretty sort of simplistic conversation where it's like most people are either going debt's bad, shouldn't use it at all, and then other people aren't doing that, or like, well, there's only a couple of ways you can use debt, but there's actually more ways that you can use debt to increase your wealth, and so there are a couple that we talk through, and I reckon there are probably some of the best opportunities that exist for our generation, and I want to do more of a deep dive in this in the future, to be honest, because we do have a couple of members in the program that have used these. One of these were really, really effectively to massively change their situation very, very quickly as well. Do you want to talk through these, the two less common ways that debt can be used, that really do work?
Speaker 2:Yeah, and just to extend upon your point, I don't think enough people actually explore it or even know that this is an option, let alone explore it as a way to gain what usually is one of the most important assets people own, which is basically using debt to buy into an established business. The most cold mechanism is a franchise, like being able to buy into something that's already built, it's got runs on the board, it's kind of a proven process and either borrowing money from the bank, potentially, or borrowing money from the franchise holder and saying, hey, we'll loan you this money. You were paid back over this period and you can actually do it from the profits that you'll earn from the business that you buy. That's something that can be very effective and you see it with a lot of chains, like a subway chain or a McDonald's, or you're seeing a lot of Pilates studios any time fitness gyms and often because they've developed proven business models. Then it's a lot easier to get the loans to support doing that.
Speaker 1:You can unlock equity from your home as well to buy business that way. And the franchise thing it's interesting. So if you get a good franchise and you make a good decision at the right time, the right location, you can do very well out of that. And the thing here with the business side of things is you're probably taking on a little bit more risk than you would be with property, because there's business risk which is higher, higher than just property, because everyone's going to need a house. In Australia there's a lot of demand for housing. But the flip side of that is your opportunity to increase the value of that asset very quickly is far, far greater. So if you do have a specialized set of knowledge and skills that you can add value to that business and make it more efficient, make it more effective, add more value to the marketplace, then you can absolutely smash that low down so fast and there is no limit to that. One of our guys in the program right now has absolutely done that bought into an existing business that he used to be an employee for, massively increased his income, smashed that debt down. Now the whole world looks different.
Speaker 1:I want to do a whole sort of thing on this because there's a generation of baby boomers that have built businesses that they cannot sell, because not many people are willing to go and buy or don't even know that this is an option, and every day there's a baby boomer trying to sell a business that they work their whole life to build and to the established business that has an income stream. They actually want to cash out Right, and if you walk in, you can actually have a conversation where you're like I want to give you that cash out, and they'll be like, shit, yeah, let's do, they're going to bend over backwards to make the deal for you. And so if you've built the right sort of skills, talents and you can add value to that kind of business, this is just one of the greatest opportunities that our generation just doesn't even talk about.
Speaker 2:For sure, my parents are trying to do this right now. They don't want to a tax outlet AFL merchandise and gift wear down in Kola, then just shout out. But it's very much that and so many of these guys of them selling it is a way of basically cashing in and it's funding a lot of their retirement and there's a lot of people getting to that point where they want to finish up and they want to be able to do that. And the example you're talking about one of the fellows in the program. He's an example of someone building up, being a good performer in his business and then saying to the guys that own it I want to buy in and taking a portion of that and be handsomely rewarded for it. Now Sometimes it's outside like we talked with a franchise or just exploring what businesses might be for sale.
Speaker 2:There's actually brokers that exist that go around and broker these deals so they can do a bit of exploration around that and I would say typically people would repay these loans in somewhere between two and five years yeah, super quick. It's usually one of those loans that gets cleared the most, especially if they're established businesses. There's already income and profit that can go directly towards paying this down at quite a rapid rate, and so, yeah, that also kind of lays up the second option that tends to exist. So, if they're coming up the loan from the bank or from secured against the home or even for a franchise, for example the other mechanism is and where this probably is a great opportunity, the failure you've mentioned is using what's called a vendor loan, which is basically you're borrowing the money from the person you're buying it off and saying you'll pay it back over X amount of time might be over two years or three years or five years and so, instead of you actually coming up with the cash upfront, you say hey, this business is worth 500,000. I'm going to commit to paying you that 500,000 over the next five years from the profit that I'm earning from this business itself.
Speaker 2:And usually you can do an opportunity assessment and go what are the actual cash flows right now? How long would it actually take me from the cash flow from the business to fully repay that loan? And this person selling the business obviously receives it in installments over that period. And it gives you this chance to do this handover as well, like all the opinion, the existing skill sets and all those things that exist in the business. You get this period where you have to work together to make that transition work, because they obviously want to get paid and have it work well and you're in that position where you get to draw from them to then pay that down as quick as possible so that when that loan's gone, all that extra money or that extra cash flow, the profit you get to keep.
Speaker 1:If you're listening to this right now and you're the kind of person that just loves to solve problems and just likes to dig into the nitty gritty and just likes to kind of figure things out and you've got an opportunity to do something like this versus just sock money away in the share market and work a job you hate, don't do it Like, explore all your options here, because it's very possible that you could walk into a business. Give that person that cash out. They're absolutely going to want to make it work for you. You're going to make it work for them because you actually create the income stream they want for retirement and it's in there. But you basically buy yourself a mentor for free and they set you up with the business that they've created. They've worked their whole life to create for you.
Speaker 1:And here's the great thing you bolt on the knowledge of the internet and how that works. Now to an existing business model that hasn't even thought about it. How much value can you add, how quickly? So I wanna do a whole kind of series on this, because I look at this and I say you get that way inclined and that's your kind of mindset. Why not give that a go. You're gonna learn so much.
Speaker 1:You are going to get paid to learn, and the person who you need to learn it from is incentivized to give you every, every scaric of their knowledge every scaric and you can take the best of what they've learned and add to it and, as you said before, you'll pay down this loan so fast Like you think about, like a home loan. It's a 30 year deal. This is just not even close. But the difference is at the end of that now, your income, your service ability, how much you can actually borrow it's gonna change that. We're gonna talk to that in here in a second, because that's essentially what it looks like at the end of this. Your income goes from whatever you can get on a salary. You can double, triple your income very quickly by doing this and importantly, you become two dimensional in your efforts.
Speaker 2:So it's not just what you're earning but you're also building an asset that you can then sell to somebody else. And so you almost double your return on effort just by exploring something like that. And, yeah, like those two common mechanisms like we talked about, franchise, like buying into a business that's kind of proven and is looking at that model, versus buying into a business that somebody else has been building and then taking it from there. Interesting to think about that. And I know there's probably a lot of deep dives. We're going around on this a bit.
Speaker 2:Usually the franchise it's actually something that can be quite lifestyle driven, probably a proven thing that's got all the systems, all the processes, all the technology, all everything's in place and they just wanna have someone man the ship. And it usually means there's a bit of a ceiling on how much you can earn from it. But you can buy multiple franchises, which you might see a lot of people do with the business. Like you said, if you have a problem solving, you love solving puzzles, then it's something where you can look at a business, go, hey, they've been doing a great job, but I think I can do more with it. I can take it to bigger places and has less of a ceiling, and so usually it's one. You're blowing up one business because you can be in, take it further, or a franchise model you go, is one enough, or maybe you want two or three, and then you can explore that out as well.
Speaker 1:And think about what that means for your engagement. Right, like you're in a job that you don't feel engaged in, you know that kind of problem solving type. Now you're going to get rewarded the how tightly coupled the inputs and outputs are in business. You can try something and you can see the outcome very, very quickly, and you get rewarded for it. On a number of ways, you see that you solved the problem, but also now you're making more money on the back end because you've created more value for somebody else. So you can actually change how you feel about work just by changing the nature of your work and benefit from this massive upside.
Speaker 1:I don't want to keep going on this because I could just keep talking about it for hours. Good to yeah. So, mate, just before we move on from this last point, we did say we're going to give two kind of uncommon ways that debt can be used. We just talked about the first one, which is to buy or buy into an established business. Do you want to talk about the second one? Cause there is another one here, isn't there?
Speaker 2:Yeah, so obviously we just talked about established businesses, but you can also use it to build a new business, and often that is, you can't necessarily borrow anything against that business cause it doesn't exist or anything like that. So it is exploring ways in which you can take out a loan, and the most common one here is, if you've created that equity in the home, being able to unlock some of that equity to help you cover some of the expenses that include getting it started. You know, if you're thinking about, like, setting something that's a storefront or you know it's a studio, for example, there's going to be some costs associated with actually setting that up, setting up the physical space. You know some of the systems, the technology, the software, and so it's releasing equity to help you get started and get to that point of earning as soon as possible. That's probably the most common way of doing it.
Speaker 2:The other one is also borrowing from the family bank. It's borrowing money if there's the capability within the family. It's not always a popular thing to talk about just because it's not something that everyone has the opportunity to do, but it is something that can absolutely be explored. I think Mitch mentioned, before we jumped on this episode. That bank and mom and dad is the fifth biggest bank in Australia these days, with a big transfer of wealth between generations coming third generation, fourth generation out from a post war era, and so this is something that's becoming a lot more prevalent, which is being able to use the resources of the family to help you get started on things like this.
Speaker 1:It kind of makes sense, though you think about it life cycle wise. So you're getting older, you can't make as much money from your labor or your human capital anymore yourself. You want your financial capital to do the work. That's exactly what I would do. For me it makes the most sense. I'd bet on the sweat of others and say you've got the ideas, you've got the energy, go for it and I'll get the benefit from it on the back end. Basically, yeah, I think it makes good sense. If you can do it and you believe in what you're doing and you've got good terms, why?
Speaker 2:not. And if you're the parents listening to this and this scenario and your kids are exploring this, just charge them really good rates. Put some pressure on them.
Speaker 1:Exactly. Give them some of our Yerks and Dodson's law. Calibrate that pressure correctly. It's totally right. All right, let's jump into the last part here. Okay, so we've gone through the different types of debt. We've talked about now all the different ways you can use debt, or the four different ways that you can use debt. The last part, either, we said we've got to talk about is how do you improve your borrowing power. We said before, debt is kind of this vehicle, it's this tool. It's going to really help you accelerate everything. You can make your savings work so much harder, but that's on the proviso that you can get debt. So let's talk about what you need to actually optimize for to be able to get debt.
Speaker 2:I guess when the whoever it is lending you that money most often it's going to be a bank there's really two key things that come into play, two key determinants. The first one is the serviceability, which is how confident the bank is that you can repay that loan over time. And so it's going to come down to the income that, firstly, you're earning. If it's consumer debt or at your mortgage debt, it's knowing that you've got the cash flow every single month to be able to make those repayments. When it comes to buying investments, then it's also taking into consideration some of the income of the assets you're using it to buy as well. And importantly I said some it's definitely not all the income. If you're buying investment property, it might be somewhere around 70 or 80% of the rental income that you anticipate to earn share, sometimes even less, but it is ultimately just making sure that you can actually repay that. So what you're earning, as well as what your assets are earning, play a massive role in that, and obviously right now that is a big thing, with rates being six to six and a half percent on your mortgage or on your investment loans, your income has a big part to play in this. And thinking about where you're at in your life cycles too. If you haven't started a family yet and that's something you're exploring there's gonna be maternity leave and you might come back to single income or one and a half income, stuff like that, like really important considerations, one from what the bank looks at, but then also for you, cause there is one how much you can borrow, which is how much the bank will give you. So that's the first thing service ability. The second part is security and ultimately it's what you promise to give the bank if you can't repay that loan. And so if you can't fulfill that function of service ability and actually make the repayments, they just wanna have a promise that you give them something of value to make up for, if they can sell, basically to be able to get back the value of what they've lent you.
Speaker 2:And so obviously, when you buy a home, it's the house itself. When you're looking to buy other assets, sometimes it gets a little bit split. So we talked before about if you're using the equity in the home to take out a loan to then help you buy another house. What that would mean is that deposit money for that second house is secured against your first home. So those two things can actually be separate. So what the security for that loan is, what it's secured against versus what it's helping you buy, which influences its tax deductibility.
Speaker 2:So that's the second key part, and the bank will actually look at it and say well, depending on what you're buying, that will also determine how much we're willing to give you, cause what we have a claim upon matters a lot. And so if you look at those examples we talked about before of using the equity to buy the investment property, the bank says, yeah, sweet, we'll give you 800,000 to be able to buy that asset. If you're buying shares, they might not allow you to borrow as much. You know it might be a lot less. And so the assets that you're choosing has a massive influence on the security that you have. That the bank takes into consideration when lending you money. And so those two really big ones, the serviceability and security.
Speaker 1:The serviceability part of this, as you said before, it's so, so important. I reminded this conversation over the guy maybe a week or so ago. About 1.5 million worth of assets max that he could borrow was 500 grand. And it wasn't because of the assets but like you look at it and I think most people would overindex on security we've got heaps of money. Why don't they loan you heaps of money? And it's actually because of serviceability. And here's the funny thing he's actually on a very good wage very good wage, probably 90, 95th percentile in terms of wage but now they're testing him against 10% interest rates. So the max I'll give him is 500 grand.
Speaker 1:And so there's two parts of this service ability. It's actually how much you're making, but it's also what you're spending, because you could have the great big income. And then they look through your spending and they go this blocks a mess, like yeah, he's making a shit ton of money but he doesn't keep any of it. He's got no discipline and it could actually be. You know you're making a lot of money, but as a couple you just can't figure out like how to keep the money. You just not spending really intentionally. It's very erratic. You're spending on the wrong things. They look through that spending as well and they say, well, we can't give these guys a lot because we can't trust them. Even though they're making all this money, the service ability isn't there, and it's not because of their income, it's because they're spending. So there's two parts that have to be kind of optimized as well. Important to think about, isn't it?
Speaker 2:yeah, because I think at the surface level they'll just look at go how much you're earning and, based off someone like you, how much would you anticipate you'd be spending, dependence and other things. But also there's another layer they can go to, which is what's your savings rate been, how much have you proven that you've been able to save, and that influences, like how much you actually got to put towards something like this. And so, yeah, having a really tidy cash flow, being very intentional and obviously this is where we spend a lot of our time with money mapping, the forecasting stuff having that be super clean so that you do present yourself really nicely to whoever that lender is, is a massive, massive leg up in kind of proving the case of saying, hey, I'm a worthy candidate of it, so yeah, massive role that it plays really what it comes down to is like how do you improve your borrowing power?
Speaker 1:have a good income, have a good savings rate for that income and have a good big capital base, if you can and a big part of that does come down to do you have the home, do you have that savings kind of working for you as well? So they're the three things, isn't it? Just have those three things in place good income, solid savings right, good capital base you'll have borrowing power and because of that, you'll get to benefit from that new money that's created sooner than everybody else. Good stuff, mate. Well, look, we've covered a fair bit of territory here.
Speaker 1:We've gone really down into the depths around like the different types of debt, different ways we can use debt and how to improve your borrowing power.
Speaker 1:I think the key thing that we really want to get across right is that they just there are way more ways you can use that than you really are probably thinking about, and it's not just debt is bad. Not having debt is good. There's a lot of nuance here. So hopefully this episode gave you a bit of that nuance so you can walk into a conversation with a broker and ask some really informed questions and get more out of that relationship, because your ability to use a broker that way and have a good broker know what a good broker can do for you is very, very important, and we're going to be bringing on one of Australia's best brokers, sarah Thompson, to be able to talk through some of the biggest mistakes that she sees people make when it comes to using debt and getting debt or struggling with debt, and we're going to be bringing her on over the next little bit. The other thing I wanted to sort of touch on here, too, is that we've talked about debt recycling before.
Speaker 2:If you want to recap on that, go to episode 40 and I did reference before about debt recycling, which we did an episode on recently.
Speaker 2:I think there's sometimes this gets packaged and romanticized a little bit too much. Just because it's beautifully packaged, I mean it's got a nice ring to it but I think it's something that actually helps people understand the mechanics of how you can use debt. You know, using the home and when you've got savings that you're making, not choosing between paying down your mortgage or investing. If you find yourself asking yourself that question should I pay down my home loan or should I invest instead, then it's probably a really good one just to understand the mechanics of how to actually think through that, how to kind of optimize it. Even if it's not to buy shares, it could be that you're looking to buy properties or you know other assets. This guide that I have put together is a really good way just to understand how that can work and what it means from a tax perspective and where a lot of the benefits come from with those decisions. So, even if it's not the asset you're looking to explore, I would actually dig into that just to learn a little bit more.
Speaker 1:So look, that's the shares part of this equation, and we have spoken about that in depth in the past, and if you do want to get that big, deep dive, I highly recommend it. It's. I'm going to go out on a limb and I'm going to say it's the best guide to debt recycling that exists on the internet, because I don't know anybody else has put as much time into it, and we've also just worked with a really good illustrator to really make this visual, make it really compelling. So if you do really want to understand that mechanism, I don't think it's a better place to go. I think Google agrees, because every time you Google debt recycling, it's way up the top. We're over that. This next iteration is even better.
Speaker 1:But where we're going from here in this debt series is we're going to be talking more about property. Now, there's a couple of reasons we're going to be doing this. As I said before, we have spoken more about shares in the past, we haven't really spoken more about property and, as we've alluded to earlier on in this episode, when you look at the difference between those two, we know that you're kind of limited in terms of the capital base that you can get a hold of through shares as a vehicle. But when it comes to property, you can get a much bigger capital base through the use of debt and in some way it's actually even a safer way to do it. You might argue about that, but it's safer in the sense that it's housing. It's more of a necessity for people, and we'll be going more into that, into the actual depths of that, through these conversations. But this is where we're going to be going from this series forward.
Speaker 1:We're going to be bringing on some of Australia's best experts when it comes to the use of debt and property and we're going to be talking to Ceri Thompson from Loan Market. Ceri is one of Australia's best mortgage brokers. She's written more than a billion dollars worth of loans, has a lot of experience. And then we're going to be talking to Goose McGrath. Goose is well runs one of Australia's fastest growing real estate businesses DashDot.
Speaker 1:And then we're also going to be talking to Bryce Holdaway as well. Bryce is one of the OGs of property here in Australia and started the PropertyCouch podcast way back when podcast were a very, very new thing, and so he really really knows his stuff. So we've got a nice contrast of views, different ways of approaching this problem and our goal is to give you, I guess, different angles, different ways to look at this, to be able to think through decisions about property, because when it comes to property, most of the risk won't be in the debt, it'll be in the property you buy with debt, and this is where you really want to kind of think your way through it and it is one of the bigger decisions you'll make. So our goal is to really just give you a look at this problem from all these different angles so you can think more clearly about it. Anything you want to add to that before we take off.
Speaker 2:I think that's a good layup. The only thing I would probably add is talked before about how it could potentially be a better way of using debt. You know, using this asset class property is the realization that we've had around. When more of it is created like we talked in that last episode, there's more from the central bank it gets expanded upon at the commercial bank level. A lot of that flows into the property market here in Australia and you being on the right side of the system, kind of alludes you to the fact that that's probably a nice place to be, and so that is a really big factor.
Speaker 2:I think, like you touched on, how much you're able to borrow for buying shares and how much you're able to borrow for buying properties is quite different, and so if you've got a hundred grand in the bank and you want to buy shares, you might borrow another hundred thousand and buy, have 200,000 an asset at base.
Speaker 2:If you've got a hundred thousand in the bank and you want to buy property, you might borrow 900,000 and have a million dollar asset.
Speaker 2:So there is a quite a big gap. You know it's not quite normalized to do what you call double gearing, which is loan against your shares to buy more of them, and you can push that further, absolutely, but for most people, at a comfortable rate, there's a pretty big difference between how much they're going to borrow to buy shares, how much to borrow to buy property, and so, as this is a deep dive around debt, you know it's that exploration of the asset that does help you get the most of it and use that to the greatest advantage and these conversations that are coming up like there are some really meaty insights, like decades and decades worth of experience here and observations, and also some very new information, some very new takes as well on this, and you'll start to see, I guess, where some of those statements come from and why the risk profile of property in Australia is so different to everything else, because Australia isn't the same as a lot of these other property markets and you'll learn more about that as we go.
Speaker 1:So I'm super pumped to be able to share these conversations, because I learned so much from these guys and really, really excited to be able to share the best of what they've learned over the years with you. Love it. Let's dig in.