What is the point of having equity?

[kerosam]

Hello all, good to be back again.

A question on equity. What is the purpose/s of having equity? I am thinking of drawing down equity from PPOR to purchase IP. However, that means my debt to the bank will increase. I would like to find out what do you do with equity (more investment?). So, is there a 'nirvana' state that investors, who uses equity to invest, aim to achieve eventually?

 

[Smurf1976]

Re: - What is the point of having equity?

"Borrowing" money is really buying the use of someone else's money (usually the bank's). The price you pay to buy the use of someone else's money is commonly called interest.

So you've already bought some money and you have some of your own as well. And now you're considering buying some more money. By doing so you hope to end up with more money of your own. Simple and effective as long as it actually makes a profit, otherwise you end up with less (or no) money of your own. So make sure the risks have been worked out properly...

As for the "nirvana" state, for me it would be to control sufficient assets to produce a reliable income to live off without using someone else's money to do it. That doesn't mean not buying the use of money to get there, but once I'm there I'd like to be not buying the use of someone else's money any more simply for reasons of peace of mind (risk). That's just IMO of course since many are happy to be always in debt.

 

[tech/a]

Re: - What is the point of having equity?

"Borrowing" money is really buying the use of someone else's money (usually the bank's). The price you pay to buy the use of someone else's money is commonly called interest.

Actually in kero's case it will be borrowing his own money!
There certainly is a state of "Nirvana".
But before I let loose with experienced comment,I'm sure our resident Financial Advisor "Money Tree" will be happy to assist.

 

[happytrader]

Re: - What is the point of having equity?

Hello Kerosam

My friends and I would consider it a state of nirvana if we were in 'good debt' to the tune of a million dollars or so.

Cheers
Happytrader

 

[bullmarket]

Re: - What is the point of having equity?

Hi kerosam

:iagree: 100% with Smurf1976.

Borrowing funds for investment, regardless of what is put up as security, is still essentially borrowing from a lender (typically a bank) and it's a perfectly legitimate strategy to 'gear' your returns. But bear in mind, you will also be gearing any potential losses.....basically, gearing = magnifying.

Borrowing for investments is 'good debt' since the interest is generally tax deductible. And if you can gear positively...ie..where the income generated from your investments funded by the borrowed funds is greater than the loan interest, then the overall risk on your investment is reduced to a large extent.

But if you are geared negatively...ie...investment income is less than the loan interest, then your are effectively making a loss each year (tax deductions can generally reduce the loss, but it's still a loss) and you have to rely on the capital value of the investment, after any CGT, to increase each year by at least your annual after tax loss, due to income and interest difference, just to break even. So you can see that negative gearing is riskier than positive gearing.

Just as an example, but certainly not a reccomendation, some relatively low risk listed property trusts are yielding 9+% atm and I'm sure you can get equity loans for less than that. So these would be an example of positive gearing.

Re "nirvana"...I don't think there is such a thing in investing. But the most important thing I would stress if anyone is considering using borrowed funds for investing, is to build a buffer into their theoretical maximum interest rate they're prepared to borrow at to allow for any expected/unexpected interest rate rises...ie...if you can comfortably repay a loan at say 7.5%, then either try to get a loan at 5.5% max or reduce the borrowed amount at 7.5% so that the interest repayments would be that of a 5.5% loan at the full amount.

Historically, I've seen it too many times where people get themselvs into financial trouble when they have borrowed to the hilt, with no buffer, and then struggle to meet interest payments when/if rates rise.

Imo it's still a good idea to have a buffer when positively geared, but it's even more important when negatively geared.

Good luck and hth

bullmarket

 

[bruham]

Re: - What is the point of having equity?

kerosam,

I used equity in my home when I first started to invest.
Houses, apartments, shares and managed funds.
Later taxi plates, unlisted property trusts, listed property trusts etc.
As I went on, I slowly un-crossed my cross-collateralistion.
So me taking a chance at that time proved to be a winner.
I'm still borrowing for investment properties.

"One property, one loan".
All other investing is now with my money.

bruham.