To Borrow or Not to Borrow?

I have actually met people who do not buy property because they do not want to be indebted to a bank. They wait until they can afford it, usually when they are close to retirement or even retired. They then withdraw their savings, gratuity and EPF to purchase a house. Not a wise move considering that the life expectancy for Malaysians is in the region of 75 years and they still need a considerable sum of money to retire on. There is such a thing as good debt and bad debt. Property loan certainly qualifies as good debt provided you are able to make your monthly obligations.

 
Now that you have made a decision to buy a property, the next step is to decide on a mortgage. For some there is a question of whether you should make a cash purchase or take on a mortgage. A cash purchase is fine if you are cash rich and the property is for your own stay. However, if you are buying a rental property as an investment or for your own business purpose, it is better to consider a mortgage for the following reasons:
1)   For cash flow
2)   For higher yield and leverage
3)   To  acquire  leverage  and enable you to buy more property in the near future.
 
 
When you place a large sum of money into one property it is an opportunity cost in the sense that you are unable to use the money for any other good investment, education expenses, medical expenses. You should also make sure you have at least 6 months  worth of mortgage in hand to pay for mortgage and property related expenses in the event the property is not rented out or if your business is not doing too well.
 
For example you purchase a property at RM 500,000. Legal fees, stamp duties and loan agreement will add up to about RM 50,000. This means that your total cost is RM 550,000.
 
If you rent it out at RM 1500, your yearly  income would be RM 18000.That would mean that you will be earning 3.6% on your capital of RM550,000. It would take 27.7 years to recoup your capital.
 
On the other hand if you took a loan for 90% your initial capital outlay will only add up to RM100,000. With the same rental you will be receiving a return of 18%.In addition you stand to gain from capital appreciation when you sell the property in the future. Assumption: the price of the property rises significantly enough to cover your capital outlay,mortgage and other holding costs.
 
As you can clearly see by taking a loan of 90% of the purchase price you are getting better returns on your property.
 
With the extra cash that you have in hand you can go ahead and buy another property and repeat the process of getting higher returns on your investment instead of cash purchase. By leveraging on other people’s money (OPM) you can invest in more properties.
 
However, be careful that you do not stretch yourself too thin. For every property that you buy you must set aside a reserve of about 6 months mortgage and property related expenses to tide you over in times when you do not have a tenant. For that reason also when buying a rental property only do so in areas that are easy to rent out. Not all properties for sale are worth the risk of purchasing and borrowing.
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