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To Borrow or Not to Borrow

by John Rubino on December 20, 2009 · 8 comments

I just got off the phone with a friend who’s buying some commercial real estate but isn’t sure how to pay for it. Should he use cash and own it outright, with no worries about making payments? Or should he finance it and pay off the loan with ever-cheaper dollars — in effect going long the property and short the dollar on the same deal? As we tossed around the pros and cons of debt in a world where paper money is being inflated away, it occurred to me that a lot of other people — including many homeowners — are probably asking themselves similar questions. So here’s some material that might help:

The first piece is from a Doug Casey interview in which the venerable money manager goes on at length about the coming real estate bust, tossing off predictions of 90% declines and dissing the idea of housing as an investment. Then he says this:

Now, that doesn’t mean that if I wanted a house, I wouldn’t buy it now. You can get a fixed-rate mortgage now with an artificially low interest rate on houses below the jumbo level (I think it’s about $550,000). Given where interest rates and the value of the dollars you borrow are going, that’s going to be a gift in the future.

L: But that’s not a speculation. You’re saying that if I wanted to buy a house I like, to live in, the near term might be a good time to buy.

Doug: Yes, that would make sense, if only because that fixed-rate mortgage could be practically wiped out by the inflation to come. You’re looking at what could be a very large gift. Too bad for the entity that lends you the money, but that’s what they get for playing this government-rigged game.

The next is from The Collapse of the Dollar and How to Profit From It, in which GoldMoney’s James Turk and I explore the strategy of borrowing dollars in the hope of repaying the loan with worthless pieces of confetti.

Debt: To leverage or not, that is the question. One seemingly logical strategy for profiting from a dollar collapse is to borrow as many dollars as possible, in the expectation of paying back the loans in ever-cheaper currency. A good plan in theory, perhaps, but we wouldn’t advise anyone to borrow money at this point in global financial history. The fact is, leverage is beneficial only if you’re absolutely, positively sure you’ll be able to make the payments. If you can’t then you have problems, regardless of how right you are about trends in the foreign exchange markets. So think through your obligations and cash flow. Holding a lot of dollar cash to cover your debts is not a solution, since your cash will fall in value along with your debt. Meanwhile,  unless you’re a bill collector or gold miner, your job won’t seen nearly as safe when the crisis is in full swing.

If you do decide to carry a fair amount of debt through the dollar crisis, make it the right kind of debt, which is fixed-rate. Under no circumstances should you load up on adjustable rate debt, whether credit card, mortgage, or business loans. Rates will soar when the dollar plunges, and if your financial life depends on covering a prime -plus-one loan, you’ll be very unhappy when the prime rate hits 20 percent. A fixed-rate mortgage, on the other hand, is a reasonable way to borrow, since it has all the things you want in a currency crisis. It’s very long-term, maybe the longest term that’s possible in today’s market. It’s adjustable on the downside if rates fall (through refinancing), but not on the upside if rates rise.  So how should you handle your mortgage? Depending on your circumstances, consider one of the following:

Secure your shelter. You need a roof over your head even more than you need wealth. So stop thinking of your home as an investment and start thinking of it as an essential part of your family’s security. To guarantee that you come through the dollar crisis with a home to call your own, liquidate some investments and pay off your mortgage. If the dollar collapses, your home’s value (assuming you haven’t just bought an expensive place in a wildly overvalued neighborhood) will rise in dollar terms. And even if real estate prices collapse, you’ll still have the shelter your house provides without the worry of a mortgage.

Leverage your home to make money. Instead of paying off your mortgage, keep it and use your free cash to buy gold and gold-based investments as explained elsewhere in this section. In effect, you’ll be borrowing against (or leveraging) your house in order to invest, with the expectation that gold will soar in dollar terms, while the real cost of your mortgage plunges. This bet paid off handsomely in the 1970s, and should again in the coming decade. But it only makes sense, and we can’t make this point strongly enough, if you are certain to be able to make your mortgage payments. Otherwise, it’s not worth the risk.

  • Gargamel

    Buying a property now when rates are lowest may be a bad investment. Prices and interest rates are inversly related. So yes u can by now with dollars that will depreciate but I would argue for houses that is at odds with falling future house prices. If u can pick up a foreclosure or short sale then you may find the best of both worlds.

  • Bruce C.

    Good article. The issues to consider were explained well. Especially like the sound advice to pay down variable rate debt. I would add to that any loans that could be called-in or minimum payments raised (read the fine print). Unless one needs the cash to save for contingencies, the savings in loan interest is another bonus.

  • jon

    Maybe a seller would write up a contract where no interest is paid to the lender and instead the borrower pays a divident to the lender on profits from the real estate venture and its eventual future sale value?

  • http://www.thetotalcollapse.com Mike

    I like your confetti idea, but fact is everything is so volatile and unpredictable that you have to get a whole other perspective on buying something.

  • Vega

    If you believe dollar is going to crash then the price of your property would
    sky rocket? Do you really think that is going to happen?

    The dollar will collapse, but it will be the foreign exchange value of the dollar
    that will collapse. Making everything that is imported expensive.
    This is where deflationistas are wrong.

    There will be domestic deflation. Asset prices and wages will fall. Credit will be harder to obtain. This is where inflationistas are wrong.

  • http://www.billhopen.com billhopen

    EXACTLY what the gov’t money printing plan is all about…its the only way to nominally balance the books, pay loans off in dollars worth 10 cents. Its the only way to get all the foreclosed properties to be bought up, to solve the CRE default.
    pay off debts in monopoly money/reset and start from fresh…lenders lose, borrowers win, sorry China!

    one must remember its possible to have serious economic deflation in terms of good money (gold) and hyper inflation in $us AT THE SAME TIME ~ like Zimbabwei in 2006 or Weimar Germany in 1930. Then one just declaires a “new dollar” backed by coal? grain? (something we have alot of) if devalued dollars repay credit
    obligations, technically no default occurred, you just got value screwed in the fourex move

  • R. Dudley

    Just read an interesting history on the French hyperinflation of the 1870’s on the Mises site. The government tried to set up a conversion rate for debt repayment. They picked a base year, determined the currency depriciation since, and multiplied the nominal value of the debt by that ratio. So the nominal principal of your debt got adjusted upward. It failed, since wages fell and debtors couldn’t pay even the original amount, but expect our enlightened policy makers to replicate the scheme in some form.

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