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How are you spending your borrowed money?

Very few people use debt to increase their wealth and this often divides the rich from the poor.

This theory can be easily adapted to the lifestyler. I'm often asked "what is the point of difference between those who own one or two properties from myself?" My reply: "being prepared to acquire more assets through borrowing money and servicing the debt". Many people that are wealthy today have done just that to get to where they are.

When calculating the risks in purchasing property the important factor is the debt servicing. Do you have the ability to service the debt on an on-going basis? If you can't, then any potential gain on the property would be off-set by the cost of carrying the debt. We often see in our line of work, those who become too bullish, they don't manage their debt servicing correctly or in fact, are unable to service the debt at all. Once in financial trouble, the speed with which compound interest accrues becomes really frightening. This is particularly evident in speculative investment, where those already with a high level of debt borrow a lot of money to go into a property development. It only takes the sections to not sell or the council process to not go as quickly as thought, with the interest compounding rapidly, in no time they can find themselves in financial trouble.

Here are some simple areas that you might want to consider when borrowing money.

Property of course, is the number one investment for most people. Buying good property is essential as this. When borrowing to buy these assets you are increasing your asset base. This is considered to be good debt, particularly if you can borrow at realistic rates. It is important when buying such a property that you are careful to ensure you can service the debt and be mindful that you have the option of repaying the principle and interest or paying interest only.

Borrowing to buy assets such as cars and boats etc. is not advisable. Sure these items are easy to borrow for, but once you own them, they immediately start decreasing in value. A tractor for example, bought for $90,000 can 2 years later be worth only $40,000. Or that nice car bought 4 years ago for $50,000 is now only worth $20,000. Unfortunately after the smell of the nice new car has gone, the hire purchase of $700 per month still continues unabated for the rest of the term of the loan. People also need to realise that the principle repayment on borrowed money is not tax deductible and therefore comes from the same column as your personal drawings. This sort of debt is not recommended and causes fiscal drag on your pocket.

Using borrowed money for things such as holidays, entertainment and clothing is foolish. I have talked to a number of accountants who have said you can give two people the same business and you will invariably get different results. The difference in personal drawings can run from $35,000 to $70,000. It is really important to focus on not wasting money, often huge amounts can be frittered away on consumption items such as dining out and clothing. It is very easy to do in a consumer driven society, but if you are not strong in saying no you will find your money slipping through your fingers faster than you can earn it.

So, it is important to be aware of how you are managing your money and the issues surrounding your debt. It is often necessary to get some coaching in this area and Fraser Farm Finance can help in this process. Regardless, always ensure you approach financial decisions from a logical and objective point of view.


 

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