A business owner with over 10 properties in Penang, once gave this answer when someone remarked with envy on how many he owned.

“The banks own it.” This is a clear implication that he still owes the bank a lot of money on mortgages.

Most rich people have substantial debts, especially long-term loans. To illustrate the point, here’s a hypothetical investment account.

Condition 1: To invest in Account-H, you decide how much to put in each month. You can contribute RM500 or even RM10,000 each time. There is no limitation, but it must be consistent.

There is a fixed term. It can be 10 years, 15 years, 25 years, etc. Most people take a 20-year or more tenure. Are you okay with that?

Your thoughts: “Okay…”

Condition 2: At any time, you can pay more than the amount previously determined.

For example, if you started with RM500/month, you can sometimes pay RM750, or RM2,000, or RM5,888. Anything above RM500 is acceptable, but not under RM500/month.

You might ask, “What if I pay less or didn’t pay for a few months?”

Some or all of your previous payments can be forfeited. So essentially your investment in Account-H is not safe from loss of principal.

Your thoughts: “Eh, that’s not nice.”

Condition 3: The more you pay into Account-H, the less returns you get. So as you invest regularly, your return rate goes down gradually.

Your thoughts: “Ouch… why would I invest in this account? It doesn’t make sense.”

Condition 4: The value you build in Account-H is not liquid. Don’t ask for it to be handed to you and expect to get it within weeks.

Cashing out your money involves a lot of paper work, and lawyers. You must pay for this cost too.

Your thoughts: “Why would I even consider investing in Account-H?”

Condition 5: The more you invest in Account-H, the higher the tax on your income.

These adverse conditions will undoubtedly upset you. “What are you talking abut? Get lost!” It is apparent you don’t like anything about Account-H.

Now here’s the big reveal – Account-H is an amortised housing loan, also known as a mortgage. What?

Where’s the logic?

Here’s a logical explanation on the conditions highlighted. You might want to refer to those “conditions” again.

Condition 1. A mortgage is a commitment to pay regularly without fail until the loan is fully paid off, usually in a very long time.

Condition 2. When you fail to commit to the instalment requirement, the bank can foreclose on your property. If they auction off your property at a low price, you can lose everything you paid previously.

Condition 3. For example, a property worth RM1 million which gets a rental income of RM50,000 a year is fetching a 5% yield. If you buy the property without a loan, your return rate is 5%.

When you get 90% financing from a bank, your equity is RM100,000. Your return on equity is 50% (RM50,000/RM100,000).

If your rental yield of 5% plus all future capital appreciation is higher than the mortgage interest, the leverage effect allows you to get a higher return.

As you slowly pay down your outstanding principal, you build up the equity of the property. With a higher stake, your return rate comes down.

That’s the reason that the more you pay down your mortgage, the return comes down too due to lower leverage.

Condition 4. The equity value of your property is not liquid. You can only cash out by refinancing. That involves a new loan agreement, hence the legal fees. By the time you get the money, it will be a few months later.

Condition 5. When you have rental income on a property with a loan, you can write off the mortgage interest when filing taxes. So the more you pay off the principal, the less interest you can deduct. Therefore, you might end up with more tax liability.

Account-H still doesn’t look appealing at all?

If after reading to this point, your conclusion is that you should avoid taking up a mortgage, then the takeaway advice has been lost on you.

Look closer. Think hard. Study the details. Reread the conditions highlighted and the explanations given.

Taking up a mortgage is not a fault. You use other people’s money to acquire an asset that churns out income regularly. That’s one of the best forms of leverage.

It is paying down the mortgage fast that is the problem. When you pay extra, when you commit to a shorter loan term, when you reduce the principal with your 13th-month bonus, what you are essentially doing is:

• Turning liquid cash into a non-liquid equity, which will cost more to take out later.
• Reducing the returns on your net worth because you push up the illiquid equity that does not affect the rental yield you are already getting.
• Increasing the amount of taxes you need to pay for your rental income.

“Super investors” don’t pay down their debt. Rich Dad Poor Dad author Robert Kiyosaki owns four Ferraris. But he also has US$600 million of debt. Be smarter with money.

This article first appeared in kclau.com

KC Lau’s first book Top Money Tips for Malaysians has sold thousands of copies. He launched the first online personal finance course specifically designed for Malaysians, entitled the Money Automation System. He also co-founded many other online financial courses including the Bursa Method, Property Method, Founder Method and REIT Method.