Mar 13, 2023
Leveraging assets for debt
When you have a spending goal, whether big or small, you need to plan around how that goal will be funded. Will it be funded via cash flow or cash on hand? Will you need to sell assets and/or take on additional debt? The stage of life you’re currently at may have a big impact on the decision as well. Are you still working, or are you retired? Everyone has different levels of comfort when it comes to debt, which should also be taken into consideration.
Given where inflation and interest rates are today, this environment presents complex challenges that may have a positive or negative impact on new or existing debt.
They say a dollar today is worth more than a dollar tomorrow. This is especially true in an inflationary environment, as you lose purchasing power over time. What does that mean for your debt? Inflation reduces the real value of existing debt. We think this makes healthy debt more attractive from a long-term perspective because you’re able to pay down debt, dollar for dollar, even though, on a relative basis, your dollar is worth progressively less in times of high inflation.
Interest rates surged in 2022 as a direct result of the Federal Reserve Board increasing the Federal Funds Rate to fight inflation. In fact, from March 2022 to February 2023, the Fed raised rates eight times.1 These interest rate increases have had a major impact on the cost of borrowing, pushing higher the cost of existing adjustable-rate or new debt. If you have a fixed-rate mortgage that you’ve refinanced or taken out over the past 10 years or so, you’re probably in good shape as you’ve likely locked in a rate lower than today’s averages. If you have adjustable-rate debt or are looking to take on new debt at a higher rate, there is a break-even analysis that should be considered to help determine your next debt-related move.
When leveraging an asset and borrowing against it, you can perform a break-even analysis to compare the rate of interest you’ll be charged versus an expected rate of return on the asset. Broadly speaking, almost any asset can be leveraged, such as real estate, investment portfolios or even vehicles. Over long periods of time, real estate and investments will generally increase in value, while most vehicles will typically decrease in value.
Home equity lines of credit and mortgages are tools that can be used to tap into a portion of your home equity. A more stable asset like real estate can provide more predictability and peace of mind to manage the debt.
A portfolio line of credit and margin are tools that can be used to tap into the value of an investment account. Leveraging a more volatile asset, like a stock, for instance, can be very uncomfortable and risky if you don’t watch its price movements closely. Declines in stock portfolios may trigger a margin call at very inopportune times. To help protect against margin calls, it’s prudent to leave a cushion that protects you from a sudden drop in the value of your collateral.
After deciding on an asset to leverage, you’ll want to evaluate the interest rate environment relative to your timeframe of borrowing. These factors will have an impact on your decision regarding whether to borrow at an adjustable or fixed interest rate.
If you are considering a major purchase and want to explore leveraging an asset, reach out to your CI Wealth Advisor to see what debt-management options are available to you and what implications this may have (if any) on your overall financial plan.
ABOUT THE AUTHOR
Peter O'Neill, CFP
Pete counsels and advises families and individuals on holistic financial planning. His areas of expertise are in retirement planning, income tax planning, investment management and estate planning. Pete joined RegentAtlantic in 2019, and has more than ten years of experience working with high-net-worth families and individuals. He is a member of the Financial Planning Committee and actively contributes to discuss and enhance best practices for advisors providing holistic financial planning advice.
Pete graduated from St. Joseph's University where he earned a Bachelor of Science in Finance. He is a CERTIFIED FINANCIAL PLANNERTM, having received the designation from the Fairleigh Dickinson University. Pete was born and raised in New Jersey, and today he and his wife Paige live in Bridgewater with their two boys. In his free time Pete enjoys trying new restaurants and collecting wine. As a sports enthusiast, I'm a Yankees, Giants and Knicks fan and continue to work on my golf game.
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