Why do billionaires still need to take out home loans?

I don’t understand why billionaires like Kwek Leng Beng would have a mortgage. Kwek Leng Beng, for example, is worth $7.2 billion and he can buy houses like a fat man buys McNuggets. That caused me to assume rich people took out mortgages mainly to mock me. Now that I’ve lost the last vestiges of my humanity (and hence understand loans better), I know why they do it. There’s a great money lesson in it for the rest of us peasants as well:

Reason #1: Billionaires would make more money by investing it elsewhere

Let’s bring this down to our level for clarity. Say you want to buy a $250,000 flat (after subsidies), and you have enough in your bank account to pay for it all at once.

If you take a loan, you could make the $25,000 down payment, and still have $225,000 left to invest in other things.

For example, say you own a growing business, that generates returns of around 12 percent per annum. You could take loan at 2.6 percent interest (current HDB loan rate), and put your remaining $225,000 in your business.

At the end of 20 years, you would make over $2.17 million from your business. The cost of your flat, at the end of 20 years including interest, is only around $376,000. That’s a profit of around $1.79 million.

Now let’s say you didn’t do that, and just dumped all the money into paying for your flat. This would save you paying $376,000 over 20 years, but then you don’t have any returns to show for.

In effect, choosing to pay for the whole flat, instead of using a mortgage, would leave you $1.79 million poorer.

Now this will shock you, but most billionaires are good at business and investing, because they’re not all Donald Trump. They can think of a hundred other, better opportunities than tying the money up in what’s basically a fancy block of concrete.

This is especially true in Singapore. Since around 2008, interest rates have lingered at historic lows of around 1.7 to 1.9 percent. That’s even lower than the CPF interest rate, which is already the limbo pole of retirement products.

Reason #2: They have access to special loans that poor people don’t

The less you need money, the harder the bank will try to lend it to you. The reverse is also true. This is why a homeless man couldn’t borrow $2 for a cup of coffee, but a billionaire can’t use the bank’s bathroom without being loaned a bag of cash, just to wipe with, sir.

The interest rate on a loan matches the degree of risk involved. The lower the risk, the lower the interest being charged. When it comes to billionaires, there is almost no chance that they will default.

For this reason, billionaires often get special loan deals from private banks. Loan rates of one to two percent, fixed, are not uncommon. Billionaires can also take out the loan using collateral that doesn’t generate income anyway.

For example, a private bank may offer a billionaire a Lombard loan on his collection of 20 Ferraris. This could be a loan of up to 80 per cent of the value of his Ferrari fleet (which should buy a house and at least one of the Pyramids.)

Again, interest rates on these loans will be super low, since they are secured (backed by collateral.) Billionaires don’t mind that piddly interest, because it allows them to monetise assets that don’t generate revenue – the cars won’t make any money just sitting there.

Reason #3: Not all assets are liquid

This one is straightforward: it can be inconvenient or costly to liquidate certain assets.

Most people keep less than 30 percent of their assets in cash. If you were to calculate the value of all that furniture in your house, your insurance policies, your computer, etc. I’m sure it’d be way more than the amount you have in your bank account.

If a billionaire wants a particularly pricey home, like a $25 million bungalow on Sentosa Cove, he may not have that lying around in cash (also, rich people often have wealth managers, who fall into convulsions when they hear about large amounts of cash lying around and being chewed up by inflation.)

And when banks are practically begging rich people to take loans, there’s no need to go through the trouble of selling wine collections, paintings, or the last third world country they bought.

Most Singaporeans are asset rich and cash poor by the way, because that’s what happens when you combine 50 years of built up wealth with the impulse control of an escaped zoo chimp. We’re terrible with financial literacy.

What you should take away from all this

Here’s the one thing you should learn from all this: it is not always a good idea to pay off the mortgage as soon as possible.

A typical insurance policy pays out around 5 percent per annum. Some Exchange Traded Funds (ETFs) can generate returns of seven per cent per year, annualised over 10 years. These all grow faster than the cost of a typical home loan (2.6 percent for HDB loans, and around 1.9 percent and rising for private bank loans)

You should talk to a wealth manager to assess your financial situation; but in many cases, you could ultimately be losing more money by tying it up in your house instead of letting it grow.

Now, hope you understand why billionaires take out home loans 😀