I recently received an email through my contact page asking me for my opinion on taking things to the next level. One of the key questions was whether or not to pay off a super low interest auto loan or pipe that money into accumulating more rental properties.
I essentially expressed said we might be splitting hairs. A basic concept of wealth building is arbitrage and involves borrowing money at one rate and investing in something that yields at a higher rate. If you borrowed money for a car at 1% and could invest it at 5%, you would pocket the 4% profit while the passive income could be used to pay off the auto loan.
Or think of it like this: if you can afford to pay off the auto loan with your existing salary, then routing extra cash you would have used to target that auto loan into rental property can possibly yield more cash.
BUT…sometimes it feels good to eliminate consumer debts. I admit that I sold a small piece of company stock earlier this year in order to pay off a new sofa set my wife and I bought for our anniversary. I didn’t like that debt hanging over my head. I admit that it was a purely emotional decision.
Borrowing money to buy rentals and using the rental income to pay off the loans is a pretty simple basis for building wealth. But its another story to take extra capital and deliberately NOT pay off your residential mortgage at an accelerated rate. The idea there is that mortgages are one of the cheapest forms of money you can get. Leveraging home equity to invest in other opportunities, when managed suitably, can help grow your net worth.
At one time, before I bought rental property and invested in stocks, I loathed all debt and had plans to nuke our mortgage as fast as possible. But that was before I read Dr. Dave’s e-book where he made a profound point:
Mortgages have created more wealth for the middle class than any other financial instrument, more than stocks, mutual funds, bonds, savings accounts, 401K plans, and IRA’s. It is a fact. Yet, most people think of mortgages as a necessary evil at best or more commonly a “rip-off.” In reality, you should wake up every morning trying to figure out how to have more mortgages, or at least a bigger mortgage. –Dr. Dave’s e-book
This point shattered one of my core opinions on debt and building wealth. The evidence presented in his e-book was incontrovertible. After realizing the truth in this, it took me another six months to actually consider applying these concepts in reality. So, through this lens, an super low rate auto loan could be considered another source of capital. Paying it off early could eat up potential investment capital.
It’s basically a comfort question. I draw the line at furniture, auto loans, and home appliances, things I have dealt with paying for over the past three years. I prefer to get them off the books quickly. But like I said, we could be splitting hairs. You don’t have to do it that way.
Whether you can route an extra $500/month into a mortgage, your stock holdings, or simply paying off some debts, I don’t think there is a fundamental right or wrong approach. Just be sure you are paying off the debts on schedule to avoid fees, unnecessary interest, and other risks. Same goes for paying off a HELOC with dividend payments.