Useful Article, but…

Posted on December 10, 2008
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I love reading Personal Finance blogs. Usually I find good information, but sometimes I read something that just doesn’t make sense. Earlier this month, Rich Credit Debt Loan had a pretty good article on getting out of the paycheck to paycheck cycle. Most of the information is solid. Then, out of nowhere, towards the end he talks about leveraging debt to create a passive stream of income. Now, I think leveraging debt can be a good way to generate income, but what he’s talking about (getting a low interest loan and putting the money into a high yield savings account) makes absolutely no sense.

Let’s do the math. The cheapest loan I could find advertised anywhere is a 3/1 ARM at 4.125%, while the highest yielding account I could find pays 6.01%. The 6.01% is not guaranteed (it could go down at any time) and the amount of deposit is limited to $25,000. So let’s borrow the $25,000. Let’s assume that we’ll be able to get our loan at the best possible rate, there won’t be any loan origination fees, and the interest we earn will never go below the initial 6.01%. Our net earnings will be 1.885%, so on a $25,000 deposit we’ll earn about $471 per year, or less than $40 per month. I’m not a big fan of taking equity out of one’s primary residence unless it’s for a very good reason – and to me, $40 per month doesn’t seem like a very good reason.

So, how could we do better? One easy way is to use a credit card that pays cash back. For example, my American Express card pays 3% on gas purchases, 2% on restaurants, and 1% on everything else. My partial budget looks something like this:

We buy most of our groceries at Costco, so we get an extra 1% back on those. By using my American Express card, I’m not doing too bad compared to borrowing money to put into a high yield savings account. In fact, by the time loan origination fees, etc are considered, I’m probably doing better.

There are other ways you can do better than $40 per month as well. Consulting. EBay. Freelancing. Writing. All of these can earn you more than $40 per week with just a few hours invested. To me, this is a much better return for your time and effort than borrowing money to get a very low net rate of return.

Cheers,

Ken

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