I wrote a post a long while ago … actually, it was my 5th-ever post – some say that I should have stopped there 😉 – about the classic Rent or Buy dilemma for your own home … and, I just (!) received an interesting comment to that Post from Joy:
That’s the silliest thing I’ve ever heard – borrow against your house (aquire more debt) to invest??? Paying off your house early and being debt-free allows you to do whatever you want with your income, THAT’s truly the way to wealth.
Believe me, I have thought about trying to pay off my mortgage early. But since I have an investment condo which is mortgage free (yeah! paid that one off in 2007) I have been a bit hesitant to use my current excess cash to pay extra toward my primary home’s principal.
Now, this sparked a whole series of comments, including this comment from ‘Chris in Boston’ who said:
This is interesting. Usually you hear from personal finance people that its best to take on the longest fixed rate mortgage you can afford. This allows you to tie up as little cash in a non liquid asset as possible (slowly building equity). Also allows you to protect that pile of cash from the effects of inflation. The house is bought in today’s dollars and paid off over 30 years in today’s dollars.
Sure, when you own a property you have to compare it to owning any other investment – cost/benefit; risk/reward; all the usual stuff. You also need to compare the costs of holding it (including interest) against the costs of investing elsewhere.
But, this last piece in Chris’ comment is THE critical point: “the house is bought in today’s dollars and paid off over 30 years in today’s dollars”.
You see, the one thing that makes owing a property, even your own home, very different to any other investment is that it can be easily financed … almost completely (remember the sub-prime crisis?).
This leads to a whole swag of benefits that I don’t think that you can get anywhere else … benefits that simply cannot be ignored by the typical saver / investor.
Here’s why …
When you mortgage a house, you and the bank enter into a partnership (typically the bank is an 80% partner and you are a 20% partner going in), but you are not in the same position:
1. You have access to ALL of the upside … so as inflation and market conditions push the value of the property upward over time, you gain 100% of the increase, the bank gets none of it.
Let’s say you buy a property for $100,000 today; you put in $20,000 deposit and the bank puts in $80,000 as an interest-only loan (forget closing costs for now) … in 20 years, if it doubles to $200,000, your share of the ‘partnership’ is now $120,000 and the bank’s is still $80,000.
You are now 60/40 majority owner of the real-estate venture! In fact, even as 20% ‘owner’ you have total control over all the decisions related to the real-estate – as long as you pay the bank on time.
2. Sure you pay the bank interest on their $80,000 share … but this is fixed (you did take out a fixed interest rate, didn’t you?!).
At 8% interest rate that’s approximately $6,400 per year … this year.
Why only this year? Because the same inflation that is increasing the value of the house (and you get to keep 100% of that increase) also decreases the effective amount that you pay to the bank; as each year goes by, the bank gets less and less in real dollars and your salary goes up.
The price of bread, milk and gas may go up, but the bank’s interest rate never will because it’s fixed!
3. You either get 100% of the value for the payments that you make to the bank (call it ‘rent avoidance’ if you live in the property) or you take 100% of the income if you decide to rent it out … all as 20% minority ‘partner’ going in. The bank on the other hand, gets their $6,400 and ONLY their $6,400.
4. The government gives you tax breaks and incentives to do all of this!
Here is my advice …
Look at everything that you own as a business: if it’s your own home, separate the ownership of the property in your mind from it’s use …
… for example, even if it’s your own home, treat yourself as your own tenant and figure the rent that you would otherwise had to pay when doing the sums.
Then evaluate the investment against any other investment or ‘business’ … and ask yourself:
– What ‘business’ gives you pretty damn close to 100% control for only 20% initial investment?
– What ‘business’ lets you in for only 20% initial investment, but then gives you all of the upside?
– What ‘business’ gives you only one-time multiplier on your initial investment on the downside but a five-time multiplier on the upside?
– What ‘business’ grows in your favor (and not your “partner’s” favor) merely by the effects of inflation?
By all means, pay off you mortgage and your lines of credit as you reach your financial goals and are set to retire …. you have plenty of money and just don’t need the stress, right?
But, if you’re still trying to get rich(er) quick(er)?
If you own a home, don’t pay it off … use the upside to help you buy more and more of these wonderful, one-of-a-kind, almost-too-good-to-be-true ‘businesses’ …
If you have other sources of income (businesses, investments) don’t spend it or reinvest all of it … use some of the spare cash to help you buy more and more of these wonderful, one-of-a-kind, almost-too-good-to-be-true ‘businesses’ …
That’s my advice to you, and to Joy, but only take it if you want to be rich!