Society has conditioned us to focus on interest rates like the be-all and end-all of personal finance. You can hear people talking about it all the time. It’s either an argument for why buying the brand new BMW was a good purchase because the dealership provided 0% financing or how the timing is bad to buy a home because interest rates are too high. TSo many other components of the conversation go overlooked when stuck with such a narrow focus.
Does the BMW fit your monthly budget just because you can finance it at 0%?
Will the mortgage on your new home cost you less than what you currently pay in rent or offer more benefits that can justify taking the higher interest rate?
Here’s the thing about interest rates. Just like everything else in life, they constantly change. Sure, we just went through one of the longest stretches of historically low interest rates, and it can be painful to think you missed the boat by not buying something then. But how many people were upset they borrowed money at 4% only to find rates had dropped to 3% a month later? It is a constant comparison between what we have and what others brag about doing better. In the end, there is no more of a prize for the person who got the lowest interest rate on a purchase than for the person who paid the least under the asking price.
When you know why you are making a purchase, and understand you are not locked into anything for life, interest rates become one of the least important factors in purchasing real estate, both as a primary home and for investment purposes. Before looking at how and why I brag about paying 79% interest to secure a piece of property, let’s first look at those potential homeowners who have been told to wait until interest rates start dropping. How long is that wait? Your guess is as good as mine – it could be months or even years.
If your family is growing, or you need to relocate for work, or the availability of quality rental options is lacking, waiting around for a factor outside your control will not help achieve your long-term goals. Whether the interest rate is 3% or 13% should not be a factor in living your life or delaying it for who knows how long. If the monthly mortgage payment still fits within your budget, buy the house! The interest payments can be tax deductible (consult with your CPA), and you can always refinance in the future when rates drop. By then, you will have also gained equity from a combination of payments and increased value in the home – gains you would not have realized without making the purchase.
When it comes to investing, every deal is a business decision in which interest rates are one of many factors. A few years back, we had the opportunity to purchase a mixed-use building with significant positive cash flow and capital appreciation as it was being sold for far less than what we believed it to be worth after some renovations and rent increases. The seller even agreed to hold a portion of the mortgage for two years, BUT she wanted 50k as a downpayment. We had just completed another large purchase and knew there was no way we had the capital. So, I borrowed it. As a merchant cash advance. At 79% interest. To put that in perspective, the 50k would cost me $39,500 in interest expenses – if I paid it back in 12 months or less.
No, we have a 300k balloon note from the seller and a dangerous financing situation I would not recommend to the novice investor or faint of heart. But, we know our market well. Within six months of acquisition, we doubled the rent roll and qualified for a traditional refinance through our bank. The appraisal, based on income evaluation, valued the property at 450k, or 100k more than we paid for the property. That valuation gave us the leverage to cash out some of the equity, pay back the owner 18 months earlier than promised, and repay the merchant cash advance within the year.
The property has since increased in value again due to renovations and additional rent increases, but let’s just use the 100k profit number from the example. After paying back the exorbitant loan interest of $39,500, we still made a $60,500 profit – without using a single cent of our own money.
Is there anyone out there who wouldn’t take those opportunities every day of the week and twice on Sunday?