- Joined
- Sep 14, 2007
- Messages
- 617
I bumped into a friend of mine the other day in the market. He is expecting his child just a few days after Tammy and I are expecting so naturally we had lots to talk about. In the conversation we got to talking about a new vehicle purchase that they were making and how they were concerned about the extra payment while his wife was on maternity leave as they were going to use their Home Equity Line of Credit (HELOC) to make the purchase.
I immediately had some concerns about his strategy and suggested rethinking their plan. Here is two ways to use your HELOC or LOC. One puts you further a head in the financial world and the other puts you much further behind. Lets look at the different strategies.
Option 1. Use your LOC to buy a Car.
Lets say that the car is a really nice one and has all of the latest features and therefore comes in at $50,000. At an interest rate of 2.25% amortized over 35 years the monthly payment would be 171.84. (Remember that this isn`t a car loan as that would be much higher.) At the end of 5 years the car is probably worth half of the purchase price. So lets just make the math very easy and say that the car cost them $10,000 in Interest and $25,000 in depreciated value for a total debt of $35,000. Unless they were buying this through a business (which they were not) then there wouldn`t be any tax offsets for this purchase
Option 2 Use your LOC to buy an Investment Property
Now let`s take that $50,000 LOC and buy an investment property worth $250,000. (Again I am going to use easy numbers to make my point and they may not be real life numbers). They rent out the property for 5 years and each month they pocket $250 in profit from the rent, pay down the mortgage another $250 monthly and the house value is now $300,000. At the end of the day they have $80,000 in there pocket.
But lets not forget about the interest payments on the LOC that cost them $10,000. There is one VERY LARGE difference though......IT IS TAX DEDUCTIBLE BECAUSE IT WAS AN INVESTMENT!!! So let`s cut it down to $7500 (Again I am using easy numbers here to make my point and they may not be real world numbers)
This constitutes a profit of $72,500 opposed to a debt of $35,000.
But what about his need for a new safe car for his family you say. Do you think the monthly cash flow of $250 would pay for a leased or financed vehicle...probably not a $50,000 vehicle but it would pay for a $30,000 car he is still much much further ahead!!
If one friend took Option 1 to have that fancy new car and another friend took Option 2 and sacrificed the sexy new car at the end of 5 years there would be $100,000 difference in their net worth.
It is simple yet very effective investment and purchasing choices like this one that financially separate people very quickly.
I immediately had some concerns about his strategy and suggested rethinking their plan. Here is two ways to use your HELOC or LOC. One puts you further a head in the financial world and the other puts you much further behind. Lets look at the different strategies.
Option 1. Use your LOC to buy a Car.
Lets say that the car is a really nice one and has all of the latest features and therefore comes in at $50,000. At an interest rate of 2.25% amortized over 35 years the monthly payment would be 171.84. (Remember that this isn`t a car loan as that would be much higher.) At the end of 5 years the car is probably worth half of the purchase price. So lets just make the math very easy and say that the car cost them $10,000 in Interest and $25,000 in depreciated value for a total debt of $35,000. Unless they were buying this through a business (which they were not) then there wouldn`t be any tax offsets for this purchase
Option 2 Use your LOC to buy an Investment Property
Now let`s take that $50,000 LOC and buy an investment property worth $250,000. (Again I am going to use easy numbers to make my point and they may not be real life numbers). They rent out the property for 5 years and each month they pocket $250 in profit from the rent, pay down the mortgage another $250 monthly and the house value is now $300,000. At the end of the day they have $80,000 in there pocket.
But lets not forget about the interest payments on the LOC that cost them $10,000. There is one VERY LARGE difference though......IT IS TAX DEDUCTIBLE BECAUSE IT WAS AN INVESTMENT!!! So let`s cut it down to $7500 (Again I am using easy numbers here to make my point and they may not be real world numbers)
This constitutes a profit of $72,500 opposed to a debt of $35,000.
But what about his need for a new safe car for his family you say. Do you think the monthly cash flow of $250 would pay for a leased or financed vehicle...probably not a $50,000 vehicle but it would pay for a $30,000 car he is still much much further ahead!!
If one friend took Option 1 to have that fancy new car and another friend took Option 2 and sacrificed the sexy new car at the end of 5 years there would be $100,000 difference in their net worth.
It is simple yet very effective investment and purchasing choices like this one that financially separate people very quickly.
