Is borrowing safe for pensioners ?
Which business borrows the most ?
Banks
If you want to set up a bank you need some money to start the business.
It is called the Capital Adequacy Ratio. In Australia it is 8% which means you need 8% in funds before you can borrow 92% from the public. The borrowing is in the form of fixed deposits and money in customer’s bank accounts.
In financial terms the Loan to Valuation Ratio (LVR) is 92%
Imagine that you want to set up a business similar to a bank and you go to your bank and say:
I have $8,000 in the bank and want to borrow $92,000
What are you going to do with the money ?
I am going to lend to other people and charge 2% more than what you are charging me
Do you have any security like property or so ?
I have $8,000
Do you think the bank will approve the loan
Not very likely but that is exactly what banks do
They put up a limited amount of money and then borrow the rest from you
Are the banks safe?
If 8% of the people want their term deposits back, the bank is bankrupt.
But the government stepped in and said we must subsidise this dangerous business and guarantee some of the funds. We do not want banks to go bankrupt because that is bad for the economy , so let’s subsidise them so they can make more profits.
Any profits the banks make is multiplied 12 ½ times. So if the bank makes 1% profit they actually make 12 ½% profit on their own money.
A normal margin between deposit and lending rates is 2% so if you put your money in a term deposit or bank account the bank makes 25% on your money and you are lucky if you get 5% ( or nothing in your trading account)
Profitable business ?. I think so
So in general, borrowing is a very good investment strategy.
Indeed if you borrow money for an investment and you are certain that the return of the investment is higher than the interest on the loan , it is an absolute win situation.
Borrowing also beats inflation as you are paying back a loan in deflated money.
Who can borrow?
The bank will lend you 30% of your income and 80% of rental income provided that you have sufficient security ( property)
You must have a job and regular income like a public servant or doctor otherwise the bank does not want to know you.
Small business will have all sorts of problems of borrowing money from a bank and if the bank approves a loan they will charge you 2% more or 10% more if your business income is not 100% sure.
It does not matter what your income is. Poor people can still make money. Whether you earn $25 per hour or $150 per hour as an engineer, if the cleaner borrows money for an investment in the long run they will always outperform the engineer that does not borrow.
Compound Interest ( see session 5) will do the trick
CAN PENSIONERS BORROW ?
The bank does not want to know you.
We do not take into account your pension income
You are too old.
Goodbye. Before you go, do you have any money to invest with us ?
Fortunately a pensioner can borrow from the Government. It is called the Home Equity Access Scheme ( formerly Pension Loan Scheme)
You can borrow 150% of the pension less the pension you receive so that a person on a full pension can borrow 50% or $572FN for a single pensioner and $862.60FN for a married couple. (Even more when you get rent assistance)
The interest on the loan is 3.95% which is very generous of the government as it is lower than the Reserve Bank rate (4.1%) or Government Bonds (4.4%)
What is more, you do not have to pay the interest until you die or sell the property you have used as security. You qualify if you are 65 or older ( 60 if you are with Veterans Affairs) and if you qualify if you are on a full or part pension and even if you are a self funded retiree. In the latter case you can borrow 150% of the pension or $2,587.80FN for a married couple.
Should you borrow
Hell Yes !
We have seen that if your investment has a return higher than the interest charged you should do so. So you can borrow at 3.95% to buy 100% guaranteed Government Bonds at 4.4% and laugh all the way to the bank. If you buy bank shares you make a lot more money.
But you can also borrow for medical treatment, holiday or just supplement living costs.
Your total borrowings are about ½ of the value of the property and the loan stops when you have reached that point. If you are young (65) you can borrow a bit less than when you are older.
There are a number of strategies whether you are on a full pension, affected under the income test ( Sessions 1, and 6) or under the asset test (Session 4) In the latter case we will show you how you can get a free electric car without any cost to you