What does the average person and a Billionaire like Donald Trump have in common? They have debt and in many cases lots of it.

What is the main difference between the two? The Donald Trump’s of the world typically don’t pay their own debts.

 Let me explain.

I’ve been meaning to write about this topic for quite a while and point out some of the general differences in perspectives in debt and attitudes towards it. For the average person, debt is a way to satisfy a urge or to scratch an itch if you will. The average Canadian carries an average of 2 credit cards and collectively in Canada we’ve racked up over 78 BILLION in credit card debt, regularly carrying a balance month to month. When you look further into the credit card statements you will likely find vacations, electronics, dinners, various membership dues, etc. At the end of the day the average person buys the majority of “luxury” items on credit in some way, shape or form. There are exceptions of course but generally speaking most purchases made on credit are on depreciating items. Sadly... boats depreciate too. The painfully obvious fact here is that the consumer ( everyday person ) is left with the bill and has to pay it. Also, if they are an employee and work for someone else they have to pay all their bills with post tax dollars and miss out on the ability to deduct some legitimate purchases against their taxes. More on that later.

A successful business owner, small or large (Like Donald Trump) does things differently. As an example, Mr. Trump has (very likely) hundreds of millions of dollars of debt that equal to millions in interest payments that need to be paid on a monthly basis yet he is one of the wealthiest people in North America. How can that be? 

He doesn’t pay the bills, at least not in the conventional sense.

Each of Mr.Trumps buildings have a common formula. He purchases a building, makes the necessary repairs/alterations and lines up tenants that work for the location. Nothing spectacular or unheard of but let’s look at it with “debt” in mind.

1.    When buying the building, Mr. Trump looks for bank financing for a good chunk of the monies required and potentially also lines up investors to help complete the purchase. This is debt that the bank/investors secure against the building to protect themselves.

2.    During the construction/alternation process Mr.Trump finds a great tenant to occupy the property and pay a certain amount of rent. This represents steady income.

3.      Once the purchase/construction and or alteration phase is complete, tenants move in and through the tenants income Mr. Trump is able to begin paying his investors and bank (debts ).

Successful business owners are not scared of debt, many times they embrace it ( to various degrees ) to help grow their business.  Going back to the overly simplified example above, all Mr.Trump is effectively doing is using other people’s money ( Considered Debt to him ) to purchase an asset ( the building – a income generating business ) and use the tenants rent payments ( his customers ) to cover the debts and expenses of the building and make a profit. Not only that, but the debts that are owed to the Bank and Investors are considered a tax deduction for people like Mr.Trump.

Now I’m not advocating that you go out and start buying rental homes or apartment buildings (not without the right education and mentors anyways) but the point I am making is that not all debt is bad debt.  As clearly shown here, debt ( combined with education ) can be a very good thing.

 I’m not going to buy buildings or start a business, how can I the “everyday person” have debts pay for themselves?

Here is a simple example.

Say a family owns a home that is worth 250K with a 100K mortgage @5%.  As an  average family they also carry two credit cards with a total balance of 20K @ 19.9% interest.

Their monthly “out of pocket” would look something like this (simplified):

100K Mortgage -   $536.82 Monthly

20K Credit Card -  $331.67 Monthly

Total                      -$868.49 Monthly Payments

This is typical in many households, many people pay far too much in interest charges ( 19.9% on credit cards ) because they do not know that in most circumstances they can refinance their homes to pay down their higher interest debts ( like credit cards ) with lower interest money through their available home equity.

The majority of lenders will allow a borrower to go to 80% LTV ( Loan to Value ) against their home in borrowing, many allow as much as 95% LTV with CMHC/GE High Ratio Insurance.

80% LTV against 250K = 200K maximum borrowing capacity.

In other words, if this family was to go ahead and borrow the full 200K against their home as a mortgage their financial picture would look like this.

200K Mortgage – $1073.64 Monthly

0 Credit Card -     $0 Monthly ( Paid in Full )

Total                       $1073.64 Monthly Payments

In the above scenario, the family has now accessed 100K in new borrowing power against their home and paid off the 20K credit card. This leaves the family with 80K in monies that are available to them. The average person would look at the 80K and say “this is awesome we can buy ( boat, car, vacation, insert idea here ) and it will only cost us $1073.64 per month” ( monthly mortgage payment ). Someone looking to have the debt pay for itself would say, “where can I invest this money and what kind of return would I need to earn to make this pay for itself?” After doing some due diligence, if you were able to find a fixed return product  (real estate based is my personal preference) that paid a regular return on a timely manner ( monthly, quarterly etc ) to service the debts you are on the right track.

As an example, if the family above mentioned could earn 10% per annum on the remaining 80K here is how it would affect their finances.

200K Mortgage – $1073.64 Monthly

0 Credit Card -     $0 Monthly ( Already Paid in Full )

Total                        $1073.64 Monthly Payments

80K Invested @ 10% $  666.67 Monthly Income

Total Monthly Payments     - $1073.64 (current payments)– 533.33 (investment income)

                                 $406.97 New Monthly Payment

The short of the long of it is that by implementing this kind of strategy the above mentioned family would end up consolidating their debts into one payment and then cutting that payment by more than half. Making it that much easier for that family to keep hundreds of dollars more in their pockets every single month. What’s just as exciting is the fact that all the interest paid on the invested capital ( 80K ) is also a tax deduction against the income they stand to make that year.

80K @ 5% ( interest rate money was borrowed to invest at )= $4000 tax deduction against income

Now, everyone’s circumstances are all a little different which is why I would recommend meeting with someone who is registered as Financial Planner or Mortgage specialist to figure out your personal circumstances. Little plug for The Blueprint Group  Following this kind of strategy will get you one step closer to having your debts truly pay for themselves.

Remember, banks love to loan out money, it’s their job to do so. There’s just one caveat, they want to make sure you can always pay it back so they can lend you more.

There are lots of investment products out there, it’s important to find one you can understand and meets your needs. To learn more about our real estate backed fixed income offering click here.

The information contained herein is not intended to sell securities or to solicit funds in any jurisdiction. This correspondence and the information contained herein do not constitute an offer or solicitation for the sale of any securities.  The information available within this correspondence is not intended to provide you with any financial, accounting, tax or legal advice. Neither the Blueprint Group nor any of its employees or agents are financial or tax advisers. Accordingly, please consult your own advisers.