The Power of Equity?

Canadian Real Estate magazine released an article entitled “The Power of Equity” in their November 2011 edition.  On the outset, the title of this article is misleading. One would expect this article to explain the various ways in which equity can be employed for investment purposes. The article in question, however, does not actually discuss potential uses but rather guides on how to achieve the highest bank loan. If anything, the article should be called: Things you didn’t know about how a bank calculates risk. 

The article offers various tips and little known information with regards to how risk and yield are calculated by banks when taking into account the possible rates offered. For example, in the past, a bank would consider only if credit cards were paid off, or how much of the balance was owed. Now, however, most banks take the total credit limit as their amount for debt calculation. So even if you owe nothing on your card that has a limit of $5000, the bank will still treat you as though you have a five thousand dollar debt. They suggest that the best way to mitigate this is to cancel, or lower the limit on your various cards. They also suggest consolidating your debt into one account, and so owe the amount on one card rather than spread out across several. 

Another suggestion made by this article, is not to consolidate your investment profile, but spread it out through various institutions. In contrast, you are encouraged to consolidate all of your personal debts, and to keep all of your personal debts and investments at separate institutions.  

What the article doesn’t explain is why this is a good idea. When you diversify your investments, you limit the impact that one fund mismanagement has on your total investment yield. If your investments are spread out across five banks, and one of the banks makes a mistake, you still have four others that are giving you better yields. This is why I encourage clients to start off with small investment properties that are easy to sell. Once you have a strong foundation, then you can invest in the large multi-unit buildings that bring all your investments under one roof. It is the monopoly investment principle explained by Kiyosaki: “Four Green Houses and One Red Hotel”.

The other thing the article doesn’t explain is that if you consolidate your debt, the bank can give you a better overall rate. For example instead of having 5 cards with 5 different banks all at 20% interest, you can have a line of credit from one bank at Prime plus 1%, if you have a good credit score and payment history. 

The article in the end explains not the power you gain, but how to get the greatest yield for your equity, out of the bank.