You often hear the advice, that you should eliminate all debt, before starting to invest.

However, in the following scenario it seems the opposite to be the right decision:

  • In order to be rented out, a real estate needs renovation costing 20k (for example)
  • The rent from the real estate can easily cover the mortgage and probably the additional mortgage for the repair.
  • We can easily get credit from the bank with the real estate as collateral (lets assume the real estate is worth 200k, is still being paid off, but the monthly rent can handle an additional credit)
  • historically low interest rates
  • Other opportunities can deliver a better return, than loaning money to yourself (playing bank)

Why pretend to be a bank and try to save 1.5% p.a. credit interest by paying for the repair yourself, when you can get the money from the bank and pay for the repair with the money you get from tenants?

Wouldn't it be better to let the bank handle this, while you invest your money in stocks and get avg. 4% return per year, adjusted for inflation etc.?

  • "a real estate needs renovation costing 20k" one unrelated issue, although it's just an example you can surely reduce that cost. – Fattie Mar 24 '18 at 13:37
  • I think it will end up costing more like 10k. – user1721135 Mar 25 '18 at 20:01
  • My answer assumes you don’t own the property. Yet. Is that not the case? – JTP - Apologise to Monica Mar 26 '18 at 9:42
  • I do own the property. But the mortgage is not paid off yet. Unless you understand that to mean the bank owns the property, which is not the case in EU. – user1721135 Mar 26 '18 at 13:21

It's the same argument as other related questions, just with a different structure. You are financing a risk-free expense (loan payment) with risky investments. Yes you might come out ahead, but if your risky investments fall (or don't rise as much as the loan interest rate) then you'll be worse off. The safer move is to pay the costs upfront and invest the amount that you would have made in loan payments.

Plus, you will have more incentive to reduce the cost upfront rather then just borrowing it and not feeling the impact of the costs right away.

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  • Thank you for addressing the actual question. But what if the 10k barely make a dent in the mortgage? If the additional mortgage takes 30 years to pay off (extreme case) its a time horizon for stocks which makes them a lot less risky no? – user1721135 Mar 26 '18 at 19:51
  • Then, essentially, you're financing your $10k investment over 30 years, which at 4% is about $32k. Sure the investment will likely outperform that, but you could also just pay for the repairs upfront and invest the additional mortgage payment. Similar return for much less risk. – D Stanley Mar 26 '18 at 20:38
  • That is an interesting thought. – user1721135 Mar 26 '18 at 20:59

In that case you are talking about a business enterprise. So the rules on debting are a little different.

In that case, taking on debt is a business decision that needs to be supported by income or sale values, and all the angles are considered in the business plan.

It's possible to run a business without a business plan if you are exceptionally talented. However most exceptionally talented people like that end up in bankruptcy court.

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The rent from the real estate can easily cover the mortgage and probably the additional mortgage for the repair.

There are many other posts here that discuss the costs associated with rental property. The mortgage is part of the cost (of course) but it’s just one bit. On my rental, the mortgage is just about a third of the rents. And, after expenses, it’s not like I’m making a huge amount on it.

From this quoted line, it actually sounds like you are cutting it far too close for comfort.

In response to the OP’s comment - you should look at this in the aggregate, if borrowing or not borrowing the money for the repairs is the difference between breaking even or losing money each month then the deal itself was a bad deal in the first place.

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  • OK but how is this related to the question? I need to make the repair anyway. – user1721135 Mar 25 '18 at 20:02

The advice to pay of debt is simplistic and is because most people will not get a high enough interest rate on their savings (without putting them at risk which they can not afford). Also it encourages people to pay off their debt mountain before it overwhelms them.

In this scenario it is worth considering the possibility that you could take out the loan and lose the money on the market hence costing 40k + interest on 20k. It sounds like you could perhaps afford this but if you can't then use the cash.

This same argument you make could be put forward in favour of constantly maxing out your mortgage - just be careful

Also unless you have fixed mortgage the low interest rate could go up. If your taking out a long term mortgage this rate is unlikely to stay fixed forever and could jump up to a figure exceeding what your making on the stock market.

The rent from the real estate can easily cover the mortgage and probably the additional mortgage for the repair.

If in doubt you could easily slip into a position where you are not going to get the return you hoped for (or perhaps these stocks you talk about would have done better).Just be careful here watch your bottom line and make sure you've done all the calculations (i'm sure you have) including possibilities such as months without rent.

As always what investments you make and whether you borrow to invest depends on you personal risk appetite.

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