You Don’t Get Rich by Paying Interest

I hate to state the obvious here, but sometimes the obvious has to be stated.  If you want to accumulate significant wealth, you aren’t going to do it by paying interest.  You have to collect interest.

When I use the term “interest”, it can really be any kind of investment return.  You pay interest to a bank if you take out a loan from that bank.  You earn interest (although not very much these days) from a bank when you lend your money to the bank in many cases.

But you can also get a return on your money (similar to collecting interest) in an investment.  The potential interest or investment return typically correlates with the risk involved.  If you stand to make a lot of money off of an investment, there are usually greater risks for losing the money you invest.

My issue is when I hear people say things such as, “I decided to buy a bigger house because interest rates are low and it will be a great investment in the long run.”

If you bought real estate in California three decades ago (or even 8 years ago), this would have been mostly true except that interest rates weren’t as low then.  But taking away from the boom periods in housing, buying a house is a consumer good.  If you take out a larger loan to buy a bigger house, then you will be paying more interest to the bank.  You will also be paying higher property taxes and more for upkeep.

There is nothing wrong with buying a bigger house, but it should be because you want it for what is essentially a consumption item.  You want to enjoy where you live.  Unless you get lucky with a real estate boom in your area, then it is not an investment.

This holds even more true for most other consumable items.  If you buy a nicer car than necessary, then you are just paying more for a consumable good (you only need a working car for the purpose of transportation).  If you take out a loan, you will be paying more in interest.

You don’t get rich by paying interest.  You get rich by collecting interest (or investment returns).

There are some people who have gotten rich off of investment real estate.  You may say, “Well, they took out big loans and paid a lot of interest, yet they made out really well.”  But the key here is that they collected more in investment returns (from renters) than they were paying out in interest.  The successful real estate investors usually get positive cash flow, meaning their returns are greater than their expenses.

You get rich by owning assets that produce cash flow.  This can be stocks, bonds, real estate, or a successful business.

This may sound funny coming from a guy who advocates gold.  But I’ve never claimed that anyone is going to get super rich from investing in gold.  You can get a positive real return on gold during times of significant inflation, but the primary reasons I advocate owning gold are for insurance and diversification.

Again, my key takeaway here is that you are not likely to get rich if you are continually paying interest to someone else, unless it is for a loan that is generating even more income.

In most cases, people take out loans for consumer goods.  The biggest trick is housing because people delude themselves into thinking it is a good investment when it usually isn’t.  They justify a big mortgage saying that they can deduct the interest paid on their income tax return.  This has to be one of the worst reasons possible for getting a big mortgage and paying interest to the bank.

If you want to accumulate significant wealth, don’t keep paying out interest.  Even in an inflationary environment, it doesn’t do you much good unless the underlying asset is increasing significantly.  Even if you are paying back a loan in depreciating dollars, you are still the one paying the interest.

You don’t get rich by paying interest.  You get rich by owning assets that collect interest for you.

One thought on “You Don’t Get Rich by Paying Interest”

  1. Housing is a complicated subject. For us, we live in a state with a very high income tax, so we get a hell of a good deduction from mortgage interest. This is not the case in many states. When considering all factors, we went with a large purchase on a 30 year note with a low rate. Our effective rate, when taking the deduction into account, is below 3%. I’ll just ride it out for the life of the loan. This was a difficult conclusion to come to for me, as I am extremely debt adverse and have zero debt beyond the mortgage. I ran the numbers time and time again, and I just couldn’t justify throwing a bunch extra on the house when the return is so low. Another thing I want to point out is that there is no such thing as a risk free investment. A friend of mine moved to Detroit years ago and followed Dave Ramsey religiously. He did the responsible thing and paid down his mortgage. By the time it was paid off his entire neighborhood was virtually abandoned and his house effectively worthless. Yes he has no mortgage payment, but he’s stuck there because no one will ever give him nearly as much as he paid for it.

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