At what interest rate should debt be used as a tool?
"I've been taking all the cheap fixed-rate debt banks would like to give me lately. What Rate? In practice I find the only way I get a low-enough rate on a longish-term fixed-rate loan is to use collateral. That is, auto loans and home loans. I haven't seen any personal loans with a low enough fixed rate. (Student loans may be cheap enough if they're subsidized, I guess.) Here's how I think of the rate: If you look at https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations , the average annual return on 80% bonds / 20% stocks is 6.7%, with worst year -10.3%. That's a nominal return not a real return. If you subtract taxes, say your marginal rate (the rate you pay on your last dollar of income) is 28% federal plus 5% state, then if you have no tax deferral the 6.7% becomes about a 4.5% average, with reasonably wide variation year-by-year. (You can mess with this, e.g. using tax-exempt bonds and tax-efficient stock funds, etc. which would be wise, but for deciding whether to take out debt, getting too detailed is false precision. The 6.7% number is only an average to begin with, not a guarantee.) Say you pay 4.5% on a loan, and you keep your money in very conservative investments, that's probably at least going to break even if you give it some years. It certainly can and sometimes will fail to break even over some time periods, but the risk of outright catastrophe is low. If your annual loss is 10%, that sucks, but it should not ruin your life. In practice, I got a home loan for close to 4.5% which is tax-deductible so a lower effective rate, and got an auto loan subsidized by the manufacturer for under 3%. Both are long-term fixed-rate loans with collateral. So I was happy to borrow this money paying about a 3% effective rate in both cases, well below my rough threshold of 4.5%. I do not, however, run a credit card balance; even though one of my cards is only 7% right now, 7% is too high, and it's a floating rate that could rise. The personal loans I've seen have too-high rates also. Thoughts Overall I think using debt as a tool requires that you're already financially stable, such that the debt isn't creating a risky situation. The debt should be used to increase liquidity and flexibility and perhaps boost investment returns a bit. Where you're likely to get into trouble is using debt to increase your purchasing power, especially if you use debt to buy things that aren't necessary. For me the primary reason to use debt is flexibility and liquidity, and the secondary ""bonus"" reason is a possible spread between the debt rate and investment returns." "Money is a commodity like any other, and loans are a way to ""buy"" money. Like any other financial decision, you need to weigh the costs against the benefits. To me, I'm happy to take advantage of a 0% for six months or a modest 5-6% rate to make ""capital"" purchases of stuff, especially for major purchases. For example, I took out a 5.5% loan to put a roof on my home a few years ago, although I had the money to make the purchase.  Why did I borrow? Selling assets to buy the roof would require me to sell investments, pay taxes and spend a bunch of time computing them. I don't believe in borrowing money to invest, as I don't have enough borrowing capacity for it to me worth the risk. Feels too much like gambling vs. investing from my point of view." "Average return on the S&P500 over the last 10 years has been 1.6 %; so if you'd invested in that with money borrowed at 3 % you would have lost (so far). Investing with borrowed money implies you think you can beat the market: that you're a cleverer investor than whoever decided to lend you the money. Whoever decided to lend you the money decided that you are the best (return/risk ratio) investment for their money. It might make sense to invest borrowed money if you don't need to pay it back if things go wrong: if you're an investment professional whose bonus depends on the profit you make, but who won't need to repay any loss. It might also makes sense to borrow money if you're going to 'add value', e.g. sweat equity: for example if you use it to renovate a house or (if you're a business) to hire more staff. But the question was ""What guidelines do you use"" and the answer is, ""I don't make passive investments with borrowed money."" My Dad did it, i.e. didn't repay his mortgage as soon as he could have: but that was because (back in the '70s) he had a long-term (government-sponsored) mortgage for about 1.5 % (designed to help first-time buyers or something like that), at a time when banks were paying higher interest rates on (ultra-safe) deposits." This is a very interesting question. I'm going to attempt to answer it. Use debt to leverage investment. Historically, stock markets have returned 10% p.a., so today when interest rates are very low, and depending on which country you live in, you could theoretically borrow money at a very low interest rate and earn 10% p.a., pocketing the difference. This can be done through an ETF, mutual funds and other investment instruments. Make sure you have enough cash flow to cover the interest payments! Similar to the concept of acid ratio for companies, you should have slightly more than enough liquid funds to meet the monthly payments. Naturally, this strategy only works when interest rates are low. After that, you'll have to think of other ideas. However, IMO the Fed seems to be heading towards QE3 so we might be seeing a prolonged period of low interest rates, so borrowing seems like a sensible option now. Since the movements of interest rates are political in nature, monitoring this should be quite simple. It depends on you. Since interest rates are the opportunity cost of spending money, the lower the interest rates, the lower the opportunity costs of using money now and repaying it later. Interest rates are a market mechanism so that people who prefer to spend later can lend to people who prefer to spend now for the price of interest. *Disclaimer: Historically stocks have returned 10% p.a., but that doesn't mean this trend will continue indefinitely as we have seen fixed income outperform stocks in the recent past. It's not so much the rate of the debt as it is the total cost of the debt relative to the gain you expect to see from using it to purchase something of value. I've known people who were quite happy to pay 12% on personal loans used to buy investment properties for flipping.  They're happy to pay that because conventional loans from banks require too much documentation and out-of-pocket expense.  For some investors, 12% without all of the documentation burden is money well spent. So if I'm the investor, and the interest on this 12% loan is $5,000 and I can flip a property for $20,000 after all of the other expenses, then the 12% loan was an enabler to netting $15,000 profit. This post has a great discussion on the topic. Basically, there is no single interest rate above which you should pay off and below which you should keep. You have to keep in mind factors such as It's tough to borrow fixed and invest risk free. That said, there are still some interesting investment opportunities. A 4% loan will cost you 3% or less after tax, and the DVY (Dow high yielders) is at 3.36% but at a 15% favored rate, you net 2.76% if my math is right. So for .5%, you get the fruits of the potential rise in dividends as well as any cap gains. Is this failsafe? No. But I believe that long term, say 10 years or more, the risk is minimal. I don't really see it as worth it at any level because of the risk. If you take $10,000,000 using the ratios you gave making 2% return. That is a profit of $200,000. Definitely not worth it, but lets go to 20% profit that is $2,000,000. To me the risk involved at beint 10 million in debt isn't worth it to make $2,000,000 quickly it would be pretty easy doing something wrong to wipe out everything.
"Fundamentals:  Then remember that you want to put 20% or more down in cash, to avoid PMI, and recalculate with thatmajor chunk taken out of your savings.  Many banks offer calculators on their websites that can help you run these numbers and figure out how much house a given mortgage can pay for. Remember that the old advice that you should buy the largest house you can afford, or the newer advice about ""starter homes"", are both questionable in the current market. =========================== Added:  If you're willing to settle for a rule-of-thumb first-approximation ballpark estimate: Maximum mortgage payment: Rule of 28. Your monthly mortgage payment should not exceed 28 percent of your gross monthly income (your income before taxes are taken out).  Maximum housing cost: Rule of 32. Your total housing payments (including the mortgage, homeowner’s insurance, and private mortgage insurance [PMI], association fees, and property taxes) should not exceed 32 percent of your gross monthly income. Maximum Total Debt Service: Rule of 40. Your total debt payments, including your housing payment, your auto loan or student loan payments, and minimum credit card payments should not exceed 40 percent of your gross monthly income. As I said, many banks offer web-based tools that will run these numbers for you. These are rules that the lending industy uses for a quick initial screen of an application. They do not guarantee that you in particular can afford that large a loan, just that it isn't so bad that they won't even look at it. Note that this is all in terms of mortgage paymennts, which means it's also affected by what interest rate you can get, how long a mortgage you're willing to take, and how much you can afford to pull out of your savings. Also, as noted, if you can't put 20% down from savings the bank will hit you for PMI. Standard reminder: Unless you explect to live in the same place for five years or more, buying a house is questionable financially. There is nothing wrong with renting; depending on local housing stock it may be cheaper. Houses come with ongoung costs and hassles rental -- even renting a house -- doesn't. Buy a house only when it makes sense both financially and in terms of what you actually need to make your life pleasant. Do not buy a house only because you think it's an investment; real estate can be a profitable business, but thinking of a house as simultaneously both your home and an investment is a good way to get yourself into trouble." The eligibilty of the deduction is based on what the borrowed money is used to purchase and NOT what asset is used as collateral.  So at the beginning of your mortgage, 10% of the interest is deductible because the entire loan was used to purchase the condo.  But when you withdraw money from the account the additional interest is usually not deductible.  It can get confusing with all the withdrawals and payments that will be coming in and out of the account if you happen to use it a lot like a chequing account. An easy example would be if you only paid the interest on the loan...  Say you had a $100 000 loan at 5% APY (for simplicity's sake).  After one year, you would have paid $5000 interest.  $500 of the would be deductible given that your office is 10% of the condo.  Then you buy a $1000 couch and continue to only pay interest for the next year.  You would have paid $5100 interest...  $5000 on money borrowed to buy the condo, and $100 on money borrowed to buy the couch.  So you can still only deduct $500. What happens when you pay back $500 against the line of credit?  Could you designate that 100% of the money should be applied to the non-deductible interest?  Or does it have to applied proportionally?  I don't know. I think it'd would be wise to separate the loans somehow.  Manulife may even have some tools to facilitate that.  However, I wouldn't recommend the Manulife One product.  I looked into when I was buying my house two years ago, and at that time it was too expensive.  The rate was the same that other banks were charging for a home equity line of credit (which was prime at the time).  You can replicate the Manulife One in a cheaper way using a traditional mortgage and a home equity line of credit...  The majority of the loan will be the traditional mortgage at (hopefully) a cheap rate.  Then you can use your line of credit as the chequing account. "They have forever to collect a balance from you.  Furthermore they can add whatever penalties and fees they wish to increase that balance.  Worst of all, they don't have to remind you or send you bills or any other notification.  You owed it when you left the office.  (There very well could be local laws that require notifications, but that isn't really the issue here.) That dentist has every right to deny you service until you settle the account.  Forever. The statute of limitations on collecting that debt via court: http://www.bankrate.com/finance/savings/when-does-your-debt-expire.aspx Which covers the rules on HOW LONG they have to collect the debt.  Owing the money is one thing, but the rules and tools that you creditor has to collect the debt are another.  You are probably worried about them suing you. But if you don't pay the debt (or settle in some way), that dentist can refuse to provide services to you, even if they write off the debt. Ways you can be punished by your dentist for not paying the bill are: Depending on your jurisdiction and/or type of debt, they typically only report it on your credit (if they are reporting at all) for 7 years.  Even if you pay and settle the account, it will still be reported on your credit report for 7 years.  The difference is how it is reported.  They can report that ""user133466 is a super reliable person who always pays debts on time"".  They can say ""user133466 is a flake who pays, but takes a while to pay"".  Or they can say ""user133466 is a bad person to provide services before collecting money, because user133466 don't pay bills"". Other people considering lending you money are going to read these opinions and decide accordingly if they want to deal with you or not. And they can say that for 7 years.  The idea of credit reporting is that you settle up as soon as possible and get your credit report to reflect the truth. One popular way to collect a debt to is to sue you for it.  There, each state has a different time period on how long a creditor has to sue you for a debt. http://www.bankrate.com/finance/credit-cards/state-statutes-of-limitations-for-old-debts-1.aspx If you pay part of the debt, that will often reset the clock on the statute of limitations, so be sure any partial or negotiated settlements state very clearly, in writing, that payment is considered payment in full on the debt.  Then you keep that record forever. There are other interesting points in the Fair Debt Collection Practices Act.  See Debt collectors calling? Know your rights.  They can only contact you in certain ways, they must respond to you in certain ways, and they have limits on what they can say, who they can say it to, and when they can say it.  There are protections from mean or vicious bill collectors, but that doesn't sound like who you are dealing with.  I don't know that the FDCPA is a tool you need to use in this case. You should negotiate your debt and try your best to settle up.  From your post, both parties dropped the ball, and both parties should give a little.  You should pay no or minor late fees, and the doctor should report your credit positively when you do so.  If you both made honest mistakes, they both parties should acknowledge that and be fair, and not defensive. This is not legal advice.  But you owe the debt, so you should settle up.  I don't think it is fair for you to not pay because they didn't mail you a paper.  However I also do not think it is fair for the doctor to run up fees and not remind you of the bill. Finally, you didn't bring up insurance or many other details.  Those details can change the answer." You didn't mention how much is the interest rate of your debts. It is a very simple rule.  If you think you can make more money by investing (the best way you can) in spite of having debts then go ahead and invest.  Else, if you donno what you're doing and can't make sure you earn more than what you're paying off for interest then may be you should focus on clearing up the debts first. You can read more about similar topic discussion here Now, that you've presented the interest rate of your loans i.e. 11% which is your average, then I suggest you to clear up the high interest rate loans first i.e. which are above 11%  because it is very difficult to make an investment and get returns more than 11% of what you invest.  What ever be it, now that you won't be having big events in the coming 5 years, I suggest you to clear up all your loans and stay debt free i.e. tr to become stable and tension free. You know, because you can't run away anywhere with all those loans up on your shoulders, you HAVE to clear them today or tomorrow. So, now that you're free (in the next 5 yrs) and burden less, so why not clear them up today? First and foremost, it's about changing habits.  It seems like you've learned a painful lesson with the car financing.  That's a good start.  I'd work on developing the habit of making a budget every month before you spend a penny. As for this money, I would pay off the Apple loan and put the rest in savings.  Then pay off the entire credit card balance the month before the rate increases. The point of putting the money in savings is not about making the small amount of interest.  You need to get in the habit of having money in an emergency fund and paying for unexpected emergencies out of that, not just throwing it on a credit card.  Ideally, budget over the next few months to pay off the credit card out of your income, not out of savings. Hi guys, have a question from my uni finance course but I’m unsure how to treat the initial loan (as a bond, or a bill or other, and what the face value of the loan is).  I’ll post the question below, any help is appreciated.  “Hi guys, I have a difficult university finance question that’s really been stressing me out....  “The amount borrowed is $300 million and the term of the debt credit facility is six years from today  The facility requires minimum loan repayments of $9 million in each financial year except for the first year.  The nominal rate for this form of debt is 5%. This intestest rate is compounded monthly and is fixed from the date the facility was initiated.  Assume that a debt repayment of $10 million is payed on 31 August 2018 and $9million on April 30 2019. Following on monthly repayments of $9 million at the end of each month from May 31 2019 to June 30 2021.  Given this information determine the outstanding value of the debt credit facility on the maturity date.”  Can anyone help me out with the answer? I’ve been wracking my brain trying to decide if I treat it as a bond or a bill.”  Thanks in advance, Next year, the Fed plans on unwinding the Bonds and MBS.  They'll ramp up to $50 billion a month.  At the same time we'll be selling Bonds on the market to finance the debt at a rate of $70 billion a month.  I wonder who's going to have the cash to buy the Toxic MBS and the low yield Bonds they'll be unloading on top of the usual Bonds for future debt.  Those Bonds will have to pay double digit rates before anyone will buy them.  Future generations will just get even more screwed the way the Fed has it planned. "There are two issues here: arithmetic and psychology. Scenario 1: You are presently paying an extra $500 per month on your student loan, above the minimum payments. Your credit card company offers a $4000 cash advance at 0% for 8 months. So you take the cash advance, pay it toward the student loan, and then instead of paying the extra $500 per month toward the student loan you use that $500 for 8 months to repay the cash advance. Net result: You pay 0% interest on the loan, and save roughly 8 months times $4000 times the interest on the student loan divided by two. (I say ""divided by two"" because it's not the difference between $4000 and zero, but between $4000 and the $500 you would have been paying off each month.) Clearly you are better off. If you are NOT presently paying an extra $500 on the student loan -- or even if you are but it is a struggle to come up with the money -- then the question becomes, can you reasonably expect to be able to pay off the credit card before the grace period runs out? Interest rates on credit cards are normally much higher than interest rates on student loans. If you get the cash advance and then can't repay it, after 8 months you are paying a very steep interest rate, and anything you saved on the student loan will quickly be lost. What I mean by ""psychological"" is that you have to have the discipline to really repay the credit card within the grace period. If you're not very confidant that you can do that, this plan could go bad very quickly. Personally, I've thought about doing things like this many times -- cash advances against credit cards, home equity loans, etc, all give low-interest money that could be used to pay off a higher-interest debt. But it's easy to get into trouble doing things like this. It's easy to say to yourself, Well, I don't need to put ALL the money toward that other debt, I could keep a thousand or so to buy that big screen TV I really need. Or to fail to pay back the low-interest loan on schedule because other things keep coming up that you spend your money on instead, whether frivolous luxuries or true emergencies. And there's always the possibility that something will happen to mess up your finances, from a big car repair bill to losing your job. You don't want to paint yourself into a corner. Finally, maxing out your credit cards hurts your credit rating. The formulas are secret, but I understand that if you use more than half your available credit, that's a minus. How much it hurts you depends on lots of factors."