The fact is that a bank is not only approving the mortgage based on your financial situation, but also is making sure there are no potential problems with the property. Of course, every couple of decades, the banks lose focus and lend to anyone who can fog a mirror but, for the most part, there should be some comfort that if the bank approves the transaction, the appraisal, the inspections, the termite report and the property liens have all been thoroughly checked. So you have a professional that fully understands finance and real estate looking after your interests because they are looking after theirs.
Advantage of Rate and Time
In over 25 years that I have been advising clients, I have almost never suggested they borrow money to purchase a property when they could pay cash. But today's low interest rate environment can make a case for taking out a mortgage and investing the cash. For illustration and simplicity purposes, a $100,000 loan would only cost about $133,000 to repay at a 4% rate over 15 years. So if you were to invest the $100,000 it would need to grow to more than $133,000 for you to be ahead. Unfortunately, investing this money will always involve risk, and you have to be very confident in your abilities to manage your investments to minimize losses and make a solid return.
Time is the biggest advantage. If we were to look at the simple S&P 500 index, we would be hard pressed to find 15-year time periods when the S&P would not have made money. The big exception would be going back to the depression years following the crash of 1929. Even the last 15 years, from the highs of the late 1990s through the dot-com bust, the tragedy of 9/11 and the more recent 2009 meltdown, the S&P ended up generating a positive return that would have made this strategy profitable. But all of that history is virtually meaningless because the past is no indication of the future. For this reason, we cannot conclude that just buying an S&P 500 index fund would be good enough.
Therefore, rather than spinning our wheels trying to figure this out, here is one way to implement this strategy. First, you need nerves of steel. You cannot panic if the market is not doing what you expected. Second, you have to be a believer in our economy. You have to be an optimist! You have to believe the markets will come back! Third, you cannot ever need this money for the full timeframe of the mortgage. If you think that the invested money will be a reserve fund and 5 years after purchasing your property you will raid it for a new roof or some sliding doors, then forget this strategy. Finally, you have to be able to pay the mortgage without much effort. The mortgage payment should not cramp your lifestyle. If it does, you should not have to agonize over a mortgage payment and what could be a volatile investment.
The bottom line is that if you are lucky enough to not need the money you would otherwise use to pay for the house, the there is an opportunity to make money by taking advantage of current low interest rates. Plus, if you have a significant income and you are itemizing your return, you can write off the interest; that would actually have the effect of lowering your interest rate even more. One caveat is that you have to watch out for the new tax law and the limits on mortgage deductibility. In short, if you are thinking taxes, think tax advisor.
For many, the most practical thing to do is to take a smaller mortgage that is reasonable and affordable. Instead of borrowing 75% of the value of the property, borrow 40% and feel comfortable that you have the ability to pay off the mortgage if you have to. Another strategy is to pay cash and then take out an interest-only line of credit or a fixed rate home equity loan after the closing. These loans are lower in closing costs and are usually less stressful to obtain. The answer is moderation not stress. It is important to remember that retirement is the time to relax and not stress over bills. If owing money stresses you out, then leave this strategy for someone else.
John R. Ruocco is sole owner of Asset Management Associates and has provided independent, fee-only investment advisory and portfolio management services for over 20 years. For more information and advisory fees, contact John R. Ruocco at 1-800-208-8588 or firstname.lastname@example.org in South Windsor, CT. The first consultation is always free. Information, brochure, and form ADV part II is available upon request or log-on to www.assetmanagementassociates.com. John waives his fees for veterans and their spouses for the first six months of his services.
The above is not a recommendation or solicitation of the S&P 500 as an investment or any other investment program. Please see qualified tax and or investment consult before making any decisions.