When you can earn money using other people’s money (OPM), you’re on the fastest path to building wealth. It’s a tool that billion-dollar corporations and the wealthiest people use to increase their fortunes, and you can use this strategy to your advantage as well.
The trick here is to use their money to increase your net worth. That starts with qualifying for the best possible terms, like ultra-low interest rates, and buying assets that will increase in value, supply cash flow, or both.
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What is OPM?
Other people’s money, or OPM, is slang for leverage in finance. Borrowed capital can be used to increase an investment’s potential returns as well as its risks. OPM can be used by individuals or by corporations.
Good debt and Other People’s Money?
You can drastically increase your Return on Investment (ROI) – and even achieve infinite returns – using both good debt and OPM.
Good debt is a type of OPM. A good debt is one that gives you money in your pocket. A bad debt, on the other hand, takes money from you.
For example, a car loan is a bad debt. Each month you pay for it while the car provides no income and depreciates as soon as it leaves the lot. As an example, a good investment property loan would be one that yields rental income that covers all property expenses, including debt service, while also providing monthly income.
Good debt has a downside in that you are usually only able to borrow a certain percentage of the asset’s purchase price. Based on our real estate example, that would be 70 to 80 percent of the purchase price.
Using the $100,000 example, let’s take a look at how this works. Traditionally, the amount you can borrow from a bank is only around $70-$80K. The remainder must be financed by equity borrowed from another source.
- $100,000 purchase price
- $80,000 loan at 5% interest
- $20,000 of your own money for equity
According to a simple mortgage calculator, you would pay about $8,500 each year for this loan.
After expenses are paid, you would have a net income of $2,500 ($11,000 – $8,500) if you have an annual income of $11,000 from your property.
Your return on investment for this would be $2,500/$20,000 = 12.5%.
- $100,000 purchase price
- $80,000 loan at 5% interest
- $20,000 OPM at 7% interest
The finder of the deal receives 50% of the net operating income.
Your annual loan costs would still be $8,500, but there would also be an additional cost of around $1,500 for the other people’s money you borrowed for equity based on an assumed 7% interest rate. Therefore, the total loan and OPM costs would be $10,000.
Time and Leverage
To make the most of OPM, you want to use it for as long as possible for free (or nearly free), and earn more on the deal than you’re paying. Use OPM along with your own savings to buy things that will increase your net worth.
As you build up more wealth, you’ll be approached with different types of lucrative opportunities. On your way there, you can take advantage of the types of OPM that are available to you right now.
Zero Percent Borrowing Buys You Time
As long as you have the means and drive to stick to a payment plan, zero percent borrowing offers one of the easiest ways to start increasing your net worth. You’ll need stellar credit and steady cash flow to pull this off, along with the willpower to pay off that loan without triggering interest (either by missing a payment or extending beyond the free period).
As long as you can do that, zero percent borrowing allows you to use your money to earn money for you (in retirement or investment accounts, for example) while acquiring an asset you can use. Zero percent financing doesn’t come around every day, but when it does— and you know you can manage it—use it to further your finances.
The Power of Leverage
In the world of finance, leverage means using a little bit of your money and a lot of someone else’s to buy wealth-producing assets.
For example, if you have $50,000 cash to invest, you could buy $50,000 worth of stock or you could use that money as a down payment on real estate worth $250,000 and borrow money to finance the rest. That second example uses leverage, and it’s a key principle of wealth building: using borrowed funds to purchase a larger portfolio of assets than you otherwise could.
Rental Real Estate
Investing in rental real estate sets you on one of the most well-worn paths to wealth. The fastest way to move down that path is with borrowed money, which lets you transform a relatively small down payment in to a large, income-producing property.
The true beauty of this strategy is that you’ve borrowed the money, but your tenants pay back the loan for you. You take on the risks of owning the property and owing the mortgage, but gain a combination of increased wealth and steady income.
With rental real estate, you also have the ability to use home equity loans for quick access to cash when you need it. Again, tenants will pay back the loan, making it a double win for your financial position. You can also pull equity from one property to use as a down payment for another, for increased use of leverage.
Before engaging in this potentially risky strategy, run some numbers to make sure that the combined rents will cover all of the loan payments associated with your properties. Between the banks lending the money and the tenants paying back the loans, you’ve built wealth by almost entirely using other people’s money.
Leverage Can Go Bad
When real estate values are on the decline, leverage can switch to the dark side. That’s because the borrowed amount may be greater than the current market value of the property, which can lead to losses. A similar effect happens when a rental property sits vacant, and there’s no rental income to cover the loan payments.