Leverage 2.0 - How will you leverage ?

How will you use the power of leverage ?

LEVERAGE 1.0 : I have $1 and I know how to earn $2 from it.  But earning $2 is not interesting to me.  So I found a way to borrow $30 to do it.



My debt ratio is 30:1

Supposedly after it is done, I earn $60, pay back the $30 and $5 interests/fees.  I could have earned $25 instead of $2.  This is the power of leverage, amplify my earnings.

But when things go south, I haven't earned the $60 yet but I have already owed someone $35.  I just needed more time and I CAN get more time by just paying more interest/fee.  This time its another $8.  So I will need to pay back $43 but if I could earn the $60, I still have a profit of $17.  Not as good as $25 but still better than $2.

Just in case my $60 still hasn't come in yet, I could extend my time again by paying another $10 interest/fee.  By then my potential profit is $7, much worse than $25 or $17, but still better than $2.

However eventually the interests add up so much that I don't get any profit even if I get my $60.  So it is NOT exciting again.

time            loan    interest  potential earning
1st round : $30 +    $5         $25
2nd round : $35 +   $8         $17
3rd round : $43 +  $10          $7
4th round : $53 +  $15         -$8
5th round : $68

What happened above is considered a 'traditional' scenario.  I thought I could earn $2 from $1 but I was wrong.   I use leverage to amplify my earnings, however after 5 rounds of trying I still fail and I ended up amplifying my lost!  So I have to pay $68 tuition fee to learn a lesson, both on my business skill and also on the power of double edge leverage.

LEVERAGE 2.0 : What could also happen is that when I first get my $30.  I put $15 aside.  So it would look as if I have $15 and I have borrow $30, although my $15 is actually from the $30.  So my debt ratio is only $30 : $15 or 2:1.

When I realize I couldn't get my earning in the first round, I could borrow another $60 because my debt ratio is low.  Then I pay the earlier loan and interest ( $60 - $35 ) so I still have an extra of $25 to do more business.

I can continue borrow more and more to cover my previous loan and yet I have more money to do more businesses.

time            loan   ratio  interest  buyStock  potential earning
1st round  :  $30   2:1    $5          $15              $10
2nd round :  $60   4:1    $9          $25              $26
3rd round :  $120  8:1   $17         $51              $60
4th round :  $240 16:1  $33          $103           $130

As soon as I hit my debt ratio limit, I can set aside some money as if it is my capital/earning like how I did the first time.  Says I add another $15 to make my capital to $30.  Borrowing $240 is only a debt ratio of 8:1.  This can continue indefinitely.

With this method,

• it appears as if I pay off my loan on time, every time. = good paymaster
• I gets lower interest because of my good records and higher loan amount
• I always have some extra money even before my real earning comes in = strong cash flow
• my potential earning actually increase every time as I keep turning = good strategy
• as long as I eventually realize one earning , I offset ALL my previous risks and I still make a REAL profit.

Don't get me wrong.  Although many people did the above illegally with the wrong methods.  But there are actually perfectly legal and legitimate ways.  As a matter of fact, almost ALL big businesses or even governments are doing exactly above.

As you may have observed, the risk is much higher now.  By the 4th round, I owe $273 instead of just $68 comparing to the earlier traditional method.  But with all the great benefits mentioned above (better strategy, stronger cash flow etc), this increased risk could still be justifiable.

Things still haven't really gone wrong yet with above creative strategy assuming it was done legally.

Things go wrong when

• I didn't really know how to earn $2 from $1 = it was a bluff and people found out
• I didn't really try hard at all to realize any earning 
• I didn't use the extra cash flow to grow the business
• I use the extra cash flow for new house, cars etc. = corruption

So the 'finance system' has opened a whole new world to us but at the end it is 'ourselves' who collapse it.  Don't blame the system, blame the greed and ignorance within ourselves who are playing with the power of leverage for the wrong reasons.

How will you use the power of leverage ?

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Personal Loan, Business Loan

More and more people are asking about personal or business loans recently. Many do not know where else to get one except from loan sharks (Ah Long). Hence they were left with 'no choice' but to take the risk to venture into whatever their dreams are. Actually there are quite a bunch of legitimate sources ...

Below show a list of sources who can give you a loan without any collateral ( tak payah cagaran )

just click on the image to view the big detail image

Some of them may not offer the loan as stated in above list anymore but they usually have other similar alternative products replacing above. So you can just call and let them know what your needs are. They should be able to offer something as they have been 'requested' by the government to 'assist' local entrepreneur.

The interest rate will NOT be LOW as it does not have collateral. But at least they wouldn't come paint your house red I suppose. It is their job to assess your ability to repay. Should things really go south and you have problem repay this loan later, you can try get help from AKPK.

The loan amount is not big in term of business sense. So you may really want to ask yourself why do you need a loan for whatever you want to do. Why haven't you had a saving that is enough for you to start a few thousand ringgits business ? If you are honest in answering that question to yourself, you may find a better way to finance your business.

Else whatever happened in the past may most probably happen again and you may face a lower success factor. Perhaps that is why you will need to pay a higher interest rate to learn the lesson the harder way, again !?

Don't forget credit card is a kind of loan too at 15-18% interest rate. Do get offer from as many sources as possible before considering which one to go for. NEVER NEVER NEVER go for the first one you encounter with.

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Mortgage vs Loan

Very often the terms mortgage and home loan are used interchangeably. Although it might not cause big harms but understanding the difference may bring positive impact to your personal finance ie. in Property Investment.

In fact, mortgage is the opposite of loan.

When you need extra money, someone can lend you some and in return they gain profit when you repay them. The lender may ask for collateral like your house so that if you don't repay them, they can take possession of your house, sell it and still earn a profit by doing so. They give you a loan.

If you have something valuable and you want to exchange it temporary for some money, you can prove to people how valuable your possession is and why should they give you money for it. You get your money if the lenders are satisfied their interests will be taken care of. You have just mortgaged your belongings.

Loan is a lender's contract,

mortgage is a borrower's contract.

At one instance, it may seems the same. Its just a story told from different angles. But if you think for a moment as a borrower, do you want to follow your lender's contract or should you come up with your own's ?

If you start thinking the whole money borrowing thing from your own angle and for your own interest, you may just come up with some unique and interesting arrangements.

Items that can be mortgaged are not limited to your own properties. If you are holding some collaterals from other people, you can mortgage them to higher bidders.

You don't have to mortgage 100% of your property. Since it is really up to you, you can even split a single property to 4 different mortgages and borrow money from different sources. However, you would need some very good reasons why people still want to lend you the money. But if it is a 4 sections building, it wouldn't look that ridiculous anymore, would it ?

Item that can be mortgaged does not even need to be mortar. An idea or a method can be mortgaged too. As long as someone believe in your value judgement and their interests taken care of, they can lend you money. So you can literary mortgage your property for money without giving it out as a collateral at all. Especially applicable when you are earning revenue from such properties.

Loan or Mortgage ?

Borrower or Mortgagor ?

Lender or Mortgagee ?

As mentioned earlier, this is just a matter of how the story is told. Do you want others to control your story or do you want to tell your owns ?

http://homebuying.about.com/cs/mortgagearticles/a/deedoftrust.htm

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Loan is disadvantaged to Cash but Limited !

In an earlier article, a myth was broken where it says "getting loan will Decrease your liquidating options" so if you have the cash to buy the whole thing, you should go ahead and buy it and NOT getting a loan. Because once you get a loan, you will end up disposing your item Slower and get back Less worth - which is the opposite of liquidation.

That message has disturbed a lot of old friends who have been using loan successfully in their property investment. They have been borrowing loan in their investment for more than 10-20 years and almost always successful getting back a bigger return as a result of the loans. If loan is not a good thing or not liquidating, what has happened in the past 10-20 years, they just got lucky ?

Loan or any form of effective borrowing,

is a leverage tool.

Lets take a look at the same example used in last article; You have the option to buy an property for $100,000 and you could also get a loan where the interest is 5% for the next 10 years. Below spreadsheets show a few calculations;

The left most column in bold under "sell direct" mean if you bought with cash earlier and sell now, you would have get back this much money after the appreciation or depreciation.

The right most column in bold under "sell with loan" mean if you got the loan in the beginning, then this is what you get back in net after deducting the remaining capital.

The most important column in this article is the 2nd column from the left under "no loan - loan". It shows the difference of buying with cash vs buying with loan. If it is a positive number, it means buying with cash has an advantage earning or saving against buying with loan.

Below show 2 cases where the property could have appreciate or depreciate 10% a year ...

Case 1 : Item "appreciate" 10% a year

Case 2 : Item "depreciate" 10% a year

If you focus on the numbers in 2nd columns, they stay the same. It doesn't matter if your item increase or decrease in value, the differences between buy with cash and buy with loan are the same.

If your item appreciate, buying with loan will earn $5,000 less.

If your item depreciate, buying with loan will less $5,000 more.

It may still seems like a disadvantage to some readers up to here. But it actually is limiting the strategical cost of a transaction. No matter how the market goes, the person who got a loan will only lose $5,000 comparing to those who bought with cash earlier. In order words, the strategical cost of getting a loan is $5,000 for the 1st year.

You may also observe that this strategical cost is decreasing over the years. 2nd year the difference is less than $10,000 ( $5,000 x 2 ) and 3rd year is even less than $15,000 etc.

Limiting strategy cost no matter how the market goes is a very powerful situation in investment.

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Is Loan really Better than CASH ?

You may have heard people are claiming its better to get a car loan than buying it with cash even if you could, especially from those car salesmen. Likewise, property investment gurus say that its better to get a home loan. These are some of the key reasons why they say loan is better than cash;

• Liquidity - keep your money with you, you may need it in future.
• Income tax department may come 'disturb' you seeing that you have loads of cash.
• buying stuff with loan usually gets more gifts.

It shouldn't be too hard to realize the main reasons why people pursue you to get a loan is because they may get a share of the interest you are paying. For example, car salesmen earn double the commission when they sell you a car with loan. Property agents want you to buy more property with the limited money you have hence they can earn multiple commission instead of just once. Other than that, most others who pursue the same are most properly are just due to ignorance.

This situation is exceptionally terrible when you are buying a new car. The car salesmen will literally give you a bad service if you mention you will buy the car with cash. They will try their worst effort pursuing you to get the loan no matter what. Else they would rather NOT sell you the car at all.

Getting a loan simply mean Pay Less NOW AND Pay More at the end. To be precise, you will have to pay interest to the loan you are getting.

Loan = Cash + interest

So you will definitely be paying more when you buy something with a loan. If you do not need the facility of 'Pay Less Now', you are basically paying the interest for nothing but ignorance.

Lets clear away the simpler excuses first;

• Income tax only penalize those who earn income illegally so unless you DO have something to hide else there is really no reason to worry about any audit.
• All 'gifts' come from your own money, the more gifts you receive in a deal, the more suspicious you should worry about the real value you are receiving.

Now the toughest part is the liquidity. It will be very hard to say keeping some money with you is NOT a liquidity option. But it is not necessary always the best liquidate option.

First of all, when you buy something with cash, its just between you and the seller. However, when you get a loan to buy the same thing, there is at least an additional party involved ie. the person who gives you the loan. Its has not just become a 3 parties complexity, its actually a totally 2 different transactions and a 4 different roles play.

( with Cash )

Buyer and Seller

vs

( with Loan )

Buyer and Seller

Borrower and Lender

So in addition to the interest, you will also pay more fees when you get a loan. When you want to sell your item, you will need to pay this fees again and perhaps also getting approval from this lender. Relatively a cash purchased item can be sold off immediately. From this perspective, doesn't cash purchase sound like a more liquidated option ?

Lets say you could buy something with cash at $100,000. You may also get a 5% loan and pay $1,060 monthly for the next 10 years.

Lets say half way down the road on the 5th year, the item has depreciated to $50,000 (13% depreciation rate). If you bought it with cash, you would end with a net cash $50,000 after selling it. If you got a loan, you would have paid $63,639 in the past 5 years, meaning you still have $36,361 cash at hand. Together with the $50,000 you may think you have more than $80,000 but you still have to repay the capital left in the loan, so at the end you end with a net cash of less than $40,000 which is less than the cash purchase option.

On the other hand, lets say your item appreciate 10% a year. On the 5th year, you could sell it for $161,051. But if you got a loan in the first place, you may get back about $140,000 net, which is still significantly less.

So no matter if your item appreciate or depreciate, if you sell off your item earlier or later, buying something with loan will only end you with ;

1. slower to sell off your item because it involves 2 transactions and it cost more fees too
2. getting less cash back at the end

The last I check, disposing something off slower and getting back Less cash is NOT exactly a liquidating option at all.

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