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.
Here’s why:
– 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? 😉
The more that I invest in real estate the more I realize that if I didn’t have a lot of money the smartest thing would be to buy a house worth around 100k or less. This gives you a small mortgage payment so you can still save. When you land a better job or you come across more cash you can rent it out and buy another. Smaller house is CHEAPER to furnish too!
I’d argue your point, Michael; my husband and I own a cheap “starter” home and they just aren’t selling like they used to pre-housing bubble. In my area, a lot of folks have been unable to sell – even at VERY competitive prices – and are becoming inadvertant landlords instead.
“a lot of folks have been unable to sell … and are becoming inadvertant landlords instead.”
@ Elizabeth – There’s your problem and solution, all in one: don’t sell.
Instead, find a good property manager and take the income (and, reinvest it) 🙂
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Following your logic, you would still be better off getting the smallest home possible and putting any excess into a second property. House price appreciation would still generate gains, but you would have additional rental income (compared to getting a larger primary residence)
i’ve bought eight since 2007. I recommend you don’t buy right now, it’s just too scary. Wait until my portfolio is complete then I will sell it back to you…
Your motto should be to buy high and sell low… See ya in the Mexican Riviera.
***Correction since 2009.
@ JD – Great point!
@ Luis – If you’re selling low … then, I’m buying! 😉