Here’s a commonly asked question:
In which cases should you take credit or a loan instead of saving up?
Len correctly answers:
When the price of whatever you are looking to buy is rising faster than the interest on the loan.
But, the answer that I want to focus on is that by popular financial blogger, Pinyo who says:
Buying a house at today’s interest rates is a good example of where taking a loan could be more beneficial than saving up. You’re amortizing over 30 years and inflation would counter the interest expenses you paid over the life of the loan. In the mean time, you get to enjoy the house much sooner.
Whilst what Pinyo suggests is correct: real-estate is a great hedge against inflation; and, borrowing to purchase your home is probably the only way that most people will ever get to buy one …
… his comment actually fails to mention that it’s also a pretty good investment. Even your own home.
Let’s take a look at a simplified case of somebody purchasing their own first home (house or condo) for $100k, including closing costs. They put in a 20% deposit and take out a 30 year fixed loan, locking in at 3% interest.
Let’s also take Pinyo’s line that the interest rate just happens to offset 30 years of inflation (i.e. inflation also averages 3%), which is almost spot-on, based on the past 30 years’ average inflation rate.
Whereas Pinyo suggests that you are (a) offsetting inflation, and (b) enjoying your house …
… I think you are also making a great investment.
- Over the 30 years, at just 3% inflation, your $100,000 home would have grown in value to $237,000
- Of course, in that same 30 year period, you would have also paid your bank $52,000 interest on that $80k loan
- Don’t forget that you put in a $20k deposit, which could have been earning interest elsewhere; let’s say that you would have averaged a 5% return on this investment, so your $20k could have grown to $86k.
The bottom line is that you will make an additional $17k profit, if you buy the house instead of just ‘saving’ the $20,000.
To me, this is a clear and tangible case where borrowing (to buy your first home) is better than merely saving …
What about the repairs and maintenance cost, you ask? And, the insurance, and the land tax?
My feeling is that these would be a lot less than the rent that you no longer need to pay …
… after all, you did just buy your own first home didn’t you?