Why higher interest rates don’t matter.

Over the past few years, the main issue most property investors have been facing is higher interest rates.

?

We’ve seen mortgage rates surge from the lows of around 2% to now over 7% depending on which bank you might be talking to. One of the biggest issues I see in the current environment is that investors are getting so worried about getting the lowest possible interest rate that they are losing sight of the big picture and missing out on significant equity gains in the process.

?

Typically as investors, we do want the lowest possible interest rate. If we are paying 7% and another bank will give us 5%, why wouldn’t we want that lower rate?

?

Well, the main catch with lower interest rates is that you are likely going to be able to borrow a lot less money.

?

For example, you will usually find your lowest interest rates when you deal with the big four banks. In return they also expect you to bring plenty of equity or a decent deposit. Have a simple pay cheque that shows you can service the loan and a clean track record of making your repayments.

?

But that low rate will also likely mean you will also be able to borrow a lot less. They are giving you that low rate because the loan is perceived as less risky.

?

However, if you go and talk to a second or third-tier lender, the situation changes. They will likely offer you a higher interest rate - but your serviceability will greatly improve.

?

For example, let’s say you go to your mortgage broker to compare your options and you find that when you talk to a big four lender, you are able to get 5% and borrow $300,000.

?

But if you go to a third-tier lender, you might be paying 6.5%, but you can borrow $700,000.

?

In the short term, you will be paying more money in interest. But you are able to buy a more expensive, better-quality asset that will grow in value. If that $700,000 loan can help you buy an $800,000 asset that grows at 10% per year, then it is significantly going to outperform the smaller loan and cheaper asset.

?

The equity growth over the long term, will more than make up for any higher interest cost that you’ll be paying.

?

But this also raises a key point. To make this work you need to be buying high-quality blue chip assets that will actually perform. There’s no point buying a property that ends up doing nothing for a decade. That’s the worst-case scenario, where you pay higher interest and there is no growth.

?

But if you buy blue-chip assets in highly desirable areas with a long history of price growth, we can assume that what has happened in the past will keep on happening.

?

That’s how you use debt in an intelligent way to build wealth over time. Debt used in the right way is an incredibly powerful tool.