Many of us use OPM on a daily basis without even realizing it. For instance, each time you go to the store and use your credit card to make a purchase, you are using OPM. When you lease or finance your car, you are using OPM. When you take a mortgage to purchase your home, you’re using OPM.
Someone paid for that car so you can drive it home then pay for it later, paid for that home so you can live in it then pay later, paid for those goods and services that you purchased with your credit card so that you can utilize them now and then pay for them later.
The same way you use OPM to make those purchases without thinking twice about them, you can also use OPM to invest and build wealth.
You can build your wealth in two different ways. You can invest your own money or you can invest with other people’s money. The drawback with using your own money is that it takes time — sometimes a long time depending on your cash flow — for you to save to have a significant amount of money to invest. However, when you’re using OPM to invest, you don’t have to wait to accumulate some money to start your investment. Hence, you can start realizing some returns sooner than later.
Also, when you use your own money, the rate of return on your investment is usually more modest since all the money is coming from your pocket. On the other hand, however, when you invest with OPM, some or none of the money you invest comes from your pocket. As a result, the rate of return on your investment may be greater or even infinite.
The drawback with using OPM to invest is the Cost of Borrowing — aka interest charges. Because you have to pay interest whenever you take a loan, if the rate of return on your investment is not comfortably greater than the interest rate on the loan, then it is unwise to borrow money to invest. Your net position when you use OPM should always be an amount that makes sense and that you’re comfortable living with.
An Example Of Using OPM to Build Wealth
On March 4, 2020 we closed on an investment property. Unfortunately we had to pay cash for the property because the bank wouldn’t give us a mortgage.
The truth is, the bank did approve us for a mortgage but they had conditions that we weren’t willing to adhere to. Since we wouldn’t conform to their terms, they didn’t want to mean us half way.
I was so annoyed with the bank for not meeting us halfway and giving us the mortgage since we are long time customers having multiple mortgages with them. For this reason I decided that I wouldn’t use even a dime of my money to close the property, just for the heck of it. I would use the same bank’s money to pay for it especially since the interest rate on our line of credit was relatively low.
So we took all $478K from our line of credit to close the property, and decided we would approach another bank to refinance it after a year.
Now, who would have thought that the bank did us a favour when they didn’t meet us halfway.
Since we didn’t have a mortgage on the property, we were only obligated to the monthly interest payment and the utilities until the property was rented. As we closed at the beginning of the pandemic, and we were in lockdown, we weren’t able to rent the property until the lockdown lifted so tenancy started July 1st. So we came out of pocket for the initial deposit and the interest charges and utilities for about 4 months. The rent covered all interest charges thereafter with $600 surplus, and the tenants paid for all utilities.
So how much did that cost us, and what were the benefits from using OPM?
Let’s do some simple calculations so you get an idea.
- The interest rate on our line of credit on March 4, 2020 was 3.75%. By March 20th it had dropped to 3.25%, and then to 2.75% by April 1st. I will use 3% for the interest rate to make the calculations simple.
- Total interest charge for the year at 3% is 0.03 x 478000 = $14340
- Monthly interest charge was about $14340/12 = $1195
- The cost for electricity, gas and water was less than $120 per month
Since we carried the property for 4 months, the costs to us were:
- Interest charges: $1195 x 4 = $4780
- Utilities: $120 x 4 = $480
- The initial down payment: $40,000
- Total out of pocket for us: $40,000 + $4,780 + $480 = $45,260
In March 2021 when we approached another bank to get a mortgage on the property, the appraisal came back at $615K. After closing on the property in April 2021, the bank gave us back $483K and we had 20% equity in the home of 0.20 x $615K = $123K.
After paying back the $478K to our line of credit, we still had $5,000. And by then the rent surplus had covered all the interest and utility charges for the 4 months that we carried the property, and even given us back more than $2,000 of our initial deposit.
If you factor in the $5,000, the net amount we put in is really $33,000 and a year later we had a home valued $615K with an equity of $123K in the home.
Now, $123K / $33K = 3.73, so the amount we had put in has more than tripled after a year!
If that doesn’t help you to understand how using OPM can help you to build wealth, then you’re a very tough nut to crack! 🤣🤣
Don’t forget to always do your due diligence before investing! And if you’re using OPM, your net position should be an amount that you are definitely comfortable with!