Only Buy Appreciating Assets on Credit

by Kevin on May 21, 2008

Reflections

(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.

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Eric May 21, 2008 at 8:37 am

If I had a nickle for everytime I told someone “Never borrow money on depreciating assets”…

One thing I wanted to add…

Some people HAVE to borrow money on depreciating assets. If you need a car for transportation and you have no savings and you’re in a checkmate situation, fine…but be smart. Find a car that has nearly bottomed out in value. Any 4×4 vehicle that runs and is in decent shape will always be worth $3,000-$4,000 (at least in the inland northwest). If you buy a vehicle like that, you’ll get -nearly- what you put into it regardless of when you sell it, less the financing fees. That’s about as smart as you can be in that situation.

I personally borrowed $15,000 for a boat in 2006. The boat is a 1988 and is depreciating at an incredibly slow rate and I have no doubt in my mind that I can sell it tomorrow for about $14,500-$15,000. I was pre-approved for a $100,000 boat loan and could have the latest and greatest SeaRay 28 footer – but if I had done that I’d be $45,000 in the hole just 2 years later from sharp depreciation.

Side note: My boat is now paid for. I only carried the note for a little over 1 year.

Both of my cars are paid for as well.

———

Pay cash whenever possible.

And listen to Kevin. The mans on top of his game! SO many people need this blog, K. Kudos.

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Philip Robert May 21, 2008 at 10:19 am

Considering the mess that I’ve made using credit in the past to purchase everything from toys, dinners, massages, degrees, and God only knows what else, I’ve learned that the best plan for me is the NO DEBT PLAN. Even for purchasing assets.

In 1982 when I was 21 I found the book Nothing Down by Robert Allen. Attempting to use the concepts in this book was a disaster for me. Last year listening to the radio I first heard Dave Ramsey articulate the idea of purchasing a house with 100% Down.

Currently I have about $135,000 in debt, and I plan to have that cleaned up in 3 years. Once this is all cleaned up I’ll use the money I’ve been paying on this to save for a house, and in about 8 years I expect to make a home purchase at 100% down.

There is much talk of using leverage to increase your net worth over a short period of time. When the market is going up, leveraging seems to work well. As we have seen recently with real estate taking big hits this plan is a plan for disaster.

Don’t forget CASH is also an asset. A fact that the credit companies know very well.

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Bonnie May 21, 2008 at 4:06 pm

I agree with you that most people need a mortgage to get homeownership at first. We need to get back to the concept that we actually expect to own it outright sooner rather than later. My website gives an overview of a program we are using to benefit from the same proven banking systems that have been generating wealth for lenders for decades. We are on our way to debt freedom much faster than we could accomplish on our own!

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Kevin May 21, 2008 at 5:05 pm

@Eric: You’re exactly right. At some point financing becomes a priority just for day to day living. We run into problems when we finance those things that aren’t required for day to day living (like a TV). Especially if your boat is retaining value and you are getting solid use out of it, then that works. And it was a 1 year note, not holding it on a credit card for five years.

@Philip — keep up the good work. 100% down for a house would be mighty impressive.

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