(Photo by terren in Virginia)
Yesterday I told you not to buy depreciating assets on credit. Today I’ll share my thoughts on buying appreciating assets on credit.
For starters, let’s get some definitions hammered out.
What is an appreciating asset, and what do you mean by credit?
An appreciating asset is anything that increases with value over time after you buy it. If you bought a Picaso painting for $2 million and three years later it is worth $4 million, the asset has appreciated (gone up) in value. The picture above is a sculpture in Chicago. I’m guessing it might go up in value over time, making it an appreciating asset.
For this post I’m not going to focus on just credit cards when I say credit. Why? Well, usually you aren’t going to be buying appreciating assets on a credit card because credit limits are not very high compared to most appreciating asset costs. There are exceptions to every rule, of course. You might be able to buy some antique glassware on a credit card that ends up appreciating. However, for the most part an appreciating asset is going to be something big like a house or classic car.
Additionally credit card rates are generally too high to overcome to earn a significant return. If you’re being charged 15-30% interest, the asset would have to appreciate extremely quickly (and very high) for it to be worth using a credit card.
Why Buying a House on Credit is a Good Thing
The most obvious reason credit for large items like a house is overall very positive is the simple fact that very few people could afford to purchase homes up front with cash only. Home owners tend to be more stable and feel more control over their lives than when living in an apartment complex.
Getting people into homes is great and all, but isn’t the main benefit of using credit (a mortgage) to purchase a residence. Up until the recent housing frenzy and bust, homes generally have appreciated over time. And with mortgage rates being extremely low (5.5-6.5% for a 30 year fixed rate)… and the government giving a tax break on mortgage interest… then it makes a lot of sense to own a home.
Now I will say I am not a fan of “investing” in your house. You buy a home to live in it, not to profit from it. I don’t want to tie up my retirement plan in my home. As we have seen with the recent housing bust, that can make your wealth disappear overnight.
But watching the house appreciate over time is a nice bonus, especially since the money you received is very cheap. Today’s mortgage payment of $1,000 will over time become cheaper and cheaper to the home owner because of inflation. With a payment that costs you less in real dollars over time, plus the added bonus of even slight appreciation, home ownership is a good deal.
The Bottom Line
If you can be absolutely certain that the asset you are buying is going to increase in value by a specific amount, you can easily run the math to see if borrowing money to purchase today is a good idea. For example if I can be guaranteed that an asset I buy today for $10,000 will be worth $20,000 in one month’s time, I can afford a very high interest rate if I were to borrow the full $10,000.
If you cannot be certain or guaranteed the value will increase, you can still consider buying on credit. A home is a good example. Home prices in our area may not go up meaningfully in the next few years. We may not see a solid return on our money “invested” in the house. But over time, I can be fairly certain our house will be worth more than it is today.
The main problem people run into is they purchase assets on credit that are virtually guaranteed to go down in value. Buying a new car with 100% financing is an easy way to make sure you will lose money on the deal… every time. So not only should you try to change your behavior and only buy appreciating assets on credit, you need to avoid buying assets that are guaranteed to depreciate when you buy them.