Rising interest rates not only make people unhappy. Not so long ago, exploiting high interest rates didn’t appear on the radar screen. So the tide has turned.
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One reader, Maria, asks, “Is it better to invest when interest rates are high than to pay back principal?”
If you have a low-interest loan that is still running and you can make investments with higher returns, the decision will be easy for you. But these situations will soon be a thing of the past.
Let’s look at more recent situations.
Advance payment
For example, if you have a $300,000 mortgage that is amortized over 25 years with a 5-year term at a 6% fixed rate, your monthly payments will be $1,919. If we add $300 to the monthly payments after 2 years from the 25th monthly payment, the realized saving is $987 at the end of the 5 year term and $65,982 at the end of the 25 year payback period.
Another option, still at the 25th monthly installment, is an additional payment of $30,000. The saving at the end of the term is then $5,645 and at the end of the payback period is $71,972.
Note that at the end of a term it is also possible to make a principal payment to reduce the balance of the mortgage to be paid.
These different ways to get rid of your debt allow you to make significant savings in a safe way and provide peace of mind. Are you interested? Note that each financial institution has its own prepayment policies. To find out more, consult the loan deed you have taken out or, even better, contact your institution’s advisor, who will tell you the exact time.
Do you have an investor profile?
Rather than repay the capital, some will prefer to use the money as financial leverage. There is no shortage of business opportunities with enticing promises.
However, this path should be taken with caution. In residential construction, rental properties, both for apartments and holiday homes, have proven to be profitable over the years. You still have to be careful and not embark on an adventure with your eyes closed.
An investment example
One tool that can help you in your approach is to determine the opportunity cost of the different options. In our previous example, instead of paying back $30,000 in principal, you could use that amount as a down payment to purchase a rental property. Four units with a monthly rent of $1,500 generate an annual income of $72,000 minus expenses. By comparing the interest savings of the upfront payment to the after-tax profit you could make on the building, you can make an informed decision. Don’t forget to also calculate the increase in value of the building. If necessary, get help from an accountant who will perform this analysis.
Finally
As you can see, Maria, in the field of financial management, not everything is all white and not all is all black.
You need to consider a number of factors, including the business opportunity at hand, your profile as an entrepreneur, your risk appetite, your preferences and your goals.
Advice
Before venturing into an area where your knowledge is limited, whether it be real estate, the stock market, or cryptocurrency, it is important to take training courses to gain the knowledge needed to properly manage your project. These meetings also allow you to build a network of contacts that will be very useful to you later.
Communicate your intentions to those close to you, to those you trust. They know you well and can give you valuable advice.
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