How Debt Aversion Can Cost You A Fortune - September 2023

By Rich Harvey, CEO & Founder, propertybuyer.com.au

The very large numbers involved when purchasing a property can dent a buyer’s confidence. It’s understandable of course. We now regularly discuss homes trading for well north of a million dollars. That sort of figure exceeds the average wage by many multiples – and this often leads to debt aversion.

Debt aversion is where a buyer focuses on the large amount they’re borrowing from a financier, creating extreme anxiety. It’s a mental state that can stop them from proceeding with a purchase… and that can lead to lost opportunity.

So, finding a way to overcome debt aversion is essential to your long-term investment success.

Here are my thoughts on the best plan for avoiding debt aversion.

Good debt versus bad debt

First up, let’s discuss the difference between good and bad debt.

Good debt is borrowing funds to invest in an asset which generates a total return more than the cost (interest) of those borrowed funds.

The right property with a relatively good rental return and above-average growth prospects usually falls into this category.

Bad debt is borrowing funds to spend on a depreciating asset or disposable items, for example, racking up credit card debt for a holiday or some new clothes.

Utilising good debt is a responsible and appropriate way to improve your net wealth position.

Dealing with debt aversion

So, debt aversion is real and recognisable. The challenge is getting past the realisation that you’re committing to pay back a large sum of money (plus interest), and instead concentrate on structuring your affairs to comfortably cope with your repayments.

Here are some strategies and mindset tips that can assist.

Remember – you own a valuable asset

Debt aversion sees you thinking about how much you borrowed while seeming to forget one very important aspect… you own and control a valuable asset.

Borrowing $1 million to buy a well selected property worth $1.2 million sounds scary, but you now possess something worth $1.2 million.

Think about how your debt is offset by this source of wealth. The truth is that if the unexpected happens, a well selected property can be sold to cover your debt, and usually with a little left over.

Best of all, the longer you hold that asset the more it’s likely to be worth……and you start creating “equity” – the extremely valuable thing that is the difference between the property value and your current loan.

In concert with this is choosing your investment property wisely. Selecting one where capital growth potential is high while rental return adequately assists in servicing the loan will deliver peace of mind.

Use financial buffers

Property markets rise and fall. So do interest rates and other costs. Unexpected maintenance and repairs on an investment can result in a sudden requirement for an input of capital. The way to deal with the stresses is to be financially prepared with financial buffers.

Over time, the to-and-fro of costs will even out, the sometimes-abrupt feast or famine of property investment that can cause headaches.

Here’s some step you can take.

Firstly, don’t overextend yourself when borrowing. Agreeing to borrow an amount that’s at your absolute maximum is a crazy idea. Keeping “some in the tank” ensures you can deal with the unexpected. In any case, even when the banks give you a maximum borrowing amount, they have built in a serviceability buffer of around 3% more than the current interest rate to make sure you can service the loan.

Also, build a treasure chest of security. Put a big chunk of funds in your loans offset account – enough to cover you during times of emergency. An extended period of tenant vacancy, or an unexpected insurance event may prevent you from generating income from your asset for a time. There could even be a job loss or medical emergency that prevents you from earning income for a stretch.

Have money set aside so you can ride out the rough times. Most smart investors will hold a buffer that can adequately cover loan repayments and household running costs for six to 12 months. Having these dollars in a loan’s offset account means that your rainy-day money is helping reduce your total interest bill too.

Have a well-thought-out strategy

You need to apply a long-term mindset to your short-term decisions about borrowing money for investment – and that means formulating a strategy.

Your investment strategy will look towards your ultimate goals as an investor – whether that be early retirement or to help give your kids a head start. The strategy will break down into gradual steps the path from where you are now to where you want to be. There will be moments of acquisition or consolidation.

A great investment strategy will also look at your available resources and commitments – and how those might change as time progresses.

With all this set out, you can begin the journey towards your ultimate outcome, borrowing funds as needed safe in the knowledge that it’s all part of the plan. When bumps appear in the road, focusing on your long-term strategy allows you to keep your head and deal with the mortgage.

Having a well-structured strategy, with a buffer in place and the ability to flex when necessary, can help every investor overcome a bout of debt aversion.

Seek professional advice

We live in an age of specialisation where the top minds in their fields can be at your disposal to help you achieve your goals. To this end, drawing on guidance from an independent buyers’ advocate – along with others such as qualified mortgage brokers, accountants and legal advisors – will put things like debt aversion into perspective.

A buyers’ advocate will, for example, ensure you select the ideal assets for your financial circumstances. They can acquire properties with the right balance of rental return and capital gains potential at the ideal time for your portfolio.

When it comes to debt aversion, the anxiety can be real but don’t let that stop you from reaching your goals. Choosing not to borrow and then missing out on a great prospect can have long-term detrimental effects on your financial wellbeing. Don’t let your emotional aversion to debt prevent you from making the most of your financial opportunities. Managing your debts well can really make you wealthy.

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