Saturday, 12 May 2012

Creating 'Investing'

When I got my first home loan in 2009, the interest rate was nice and low at 5.37% per annum. During 2010 there were several interest rate rises that saw this figure go up to 6.88% by the end of 2010. In just over a year, I was paying more than 1.5% extra interest than when I first got my loan. Now it was not a big problem, because when I first decided to purchase the property, I made sure I looked at the interest rate at the time. I made sure I would be able to still service a loan comfortably even if the interest rate had gone up 3.0%, so I was still fairly comfortable but not happy with the rate rises

A friend of mine recently told me that he needed $5,500 to go on a school soccer trip to the UK. Not being able to work too often with work commitments, he was short on ideas of where to get the money. He already had about $4,000 saved up but the extra $1,500 would have been difficult to make. He was telling me that he would probably just put it in the bank, collect the 6% interest and just do odd jobs around the neighbourhood to try and save up the extra money, which he ended up doing and in the end it worked well for him.

This got me thinking...the banks will give you around 6.0% interest on savings, the interest collected is then taxed at around 35 to 45% typically. So that gives a maximum 3.9% net return on your investment. So people earn 3.9% net return while I am off paying 6.88% interest on my loan. And then it all clicked, instead of people investing their savings at the bank, why don't they 'invest' in my loan instead.

I could act like a "bank", charge my own interest while reducing the amount of interest I paid on my loan. So this is what I ended up doing with a friend of mine. He took $20,000 out of his online savings account and deposited it into my home loan account. Obviously a fair bit of trust is required to undertake this type of investment or you could draw up a quick contract which you can easily find with google. I offered him a 6% interest rate per annum, compounded daily (where the interest earned is tax free). After leaving the money there for a year, look at the comparisons below -

Initial Loan Amount - $400,000
Interest Rate on Loan - 6.88%

Friend's Savings Deposit - $20,000
Interest Rate given to friend - 6.00%

First - by doing nothing, i.e friend keeps his savings in the bank collecting 3.9% net return:
Me - Interest paid on $400,000 for 1 year = $27,520
Friend - Interest earned on $20,000 for 1 year = $780

Now - if my friend deposits money into my account and I pay him interest:

Friend - Interest earned on $20,000 for 1 year = $1,200
Me - a) Interest Paid on $380,000 for 1 year = $26,144
         b) add on interest paid to friend = $26,144 + $1,200 = $27,344

Based on the example above, my friend would stand to make an extra 54% on his interest earnings and I would make a saving of about 1%.

So without too much work, we were both able to make some money, creating a win-win situation for both of us.

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