Organize your debt

Oct
18

Addicus


Most investors, even investors with plenty of money, still don’t have a strategy.

They end up constantly playing catch-up to a market that dips and rises, tosses and turns. But strategy means stability among factors you can’t control. That’s especially important when using debt to access capital. Strategy is what turns “debt” into “leverage.” Strategy is what keeps you in the driver’s seat of your Personal Financial Enterprise.

Not the market, not the bank. You.

When structuring debt, Addicus believes it is best to have long-term, fixed-rate debt; non-callable loans, and long maturities. One of our driving philosophies at Addicus is that the bank should not have the ability to mature the debt every year, or two years, or five years. This puts the PFE in the passenger seat while allowing the bank to drive. If the investor finds themselves unable to refinance, the bank can then take the asset.

In a case where the bank wants to set these terms, paying a little more for non-callable debt is almost always a worthwhile investment. That higher interest rate is akin to an insurance policy paid against rising rates, the bank potentially reneging on the deal, or the bank deciding to not renew the loan upon maturity.

Leverage is all about protection and risk management.

For most Addicus clients, all leverage lightning rods back to them, no matter which asset is involved, meaning they are personally responsible for the borrowing through collateral-backed debt. However, if the borrower defaults on the loan, the bank can come after anything, not just the collateral asset. And there are no sacred cows — not their house, not their farm, and not their commercial investments.

This means Addicus doesn’t treat the debt leveraged against one asset greater than another. If a client’s home is paid for, but they have a business debt go bad, the lender can then come after any of their assets (even their homestead-exempted home if its value surpasses the exemption). In this instance, debt can protect the home.  Debt leveraged across multiple assets protects the borrower.

This is another important Addicus philosophy: Don’t over collateralize. Debt is debt is debt. Or, leverage is leverage is leverage.

It doesn’t make sense to offer a two million dollar piece of property for an $800,000 debt. In fact it’s a measly 40-percent loan-to-value. Assets must be leveraged to the fullest extent before considering borrowing against other assets. If a lien is required, carve out just enough of an asset (e.g. parcel up land) to give the bank so they don’t have a blanket lien on the entire asset.

When Addicus organizes leverage, it is done in accordance with a preordained asset priority list. The most attractive asset is the primary residence, followed by a second residence or vacation home, and then agricultural property or hunting land. These come first because banks and federal land banks will finance these assets on long-term, non-maturing, non-callable loans with attractive fixed-interest rates. Following these primary assets, Addicus prioritizes (in this order) owner-occupied commercial real estate, general commercial real estate, and residential investment real estate because it is harder to obtain good financing on these types of assets. Finally, there are business loans and lines of credit because they typically mature in very short term and have variable rates.

In looking at the total spectrum of a portfolio – the PFE – leverage can be arranged to effectively and efficiently accomplish most goals as long as debt is used strategically. The goal is to minimize the outflow of cash while structuring debt in way that leaves the PFE in the driver’s seat – not force the enterprise to pay debt by any terms other than those that benefit the end goal.

There is a lot more opportunity on the upside to do something productive with cash as opposed to using it to overpay debt. Even if the money is put into a low-risk portfolio, access to cash with a net-zero borrowing cost remains.

This thinking may go against the grain of everything believed and taught about debt in conventional society, but that is the mission of Addicus: to achieve better results through better informed action. Addicus does not advocate for the masses to run out and borrow money for the sake of accruing debt, but their hope is to cause consumers to reconsider the notion of debt as evil. Debt — or leverage — can help to achieve financial goals by strategically utilizing it as a tool, and ultimately allowing more control and reducing fear when seeking to acquire valuable assets.

Read more about our approach to debt in our white paper: Stop Blaming the Debt.

 

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