Leverage or Pay Down

Should You Leverage Your Home or Pay It Down Rapidly?

Should we, as loan professionals, encourage clients to borrow as much money as possible? Or would consumers benefit more if we helped them to understand the advantages of 15-year amortization schedules and pre-paying principal? Let's examine the pros and cons of both strategies.

Leveraging Your Property
In order to understand why you would want to borrow as much money as possible for your home purchase, you must first understand the concept that equity has a zero rate of return. Here's an example: If consumer "A" buys a home for $300,000 and puts 20% down, then he has $60,000 in equity. Over the next 5 years, the property appreciates $100,000 in value. Consumer "A" now has $160,000 in equity. Consumer "B" buys a home for $300,000 and puts no money down. At the end of 5 years, that same home is now worth $400,000. Consumer "B" has $100,000 in equity which is the same appreciation as consumer "A", a net $100,000.

As you can see, your down payment has nothing to do with your rate of return. What becomes important is how you choose to manage the $60,000 you didn't use as a down payment. Rather than spend it on the frivolous, such as buying toys or going to Las Vegas, use that money as a down payment. It is more prudent especially because it will enable you to obtain a lower interest rate. However, if you invested the $60,000 in a vehicle that could out-earn the cost of that debt, then it could be a formula for success. That is why putting as little down as you possibly can, maximizing your tax write-off, and investing the rest. The key component is taking the money you would have used as a down payment and putting that money to work by owning more appreciating assets like other real estate or securities.

Paying Your Home Down Rapidly
There are very few times over the course of my career that I have seen a client with zero debt and/or no financial difficulties. Choosing to pay off all your debt can reduce stress and help you to gain freedom of cash flow for investment opportunities. A 15-year mortgage strategy provides structure. It can also put you on track to have your mortgage paid off within a set timeframe. Simply put, it contains built-in discipline. It's important, however, to understand that regardless of how rapidly you pay off your home, you're not getting any greater rate of return on your investment than if you paid it off slowly.

Conclusion
So how does one determine which scenario is best? The choice depends entirely upon the individual. Savvy consumers who are disciplined and are comfortable taking chances from an investment perspective, would do well with the first scenario. It's been proven that your rate of return over the long-haul will be far greater than the rate you'd pay for a mortgage in today's rate environment.

It's important to seek the advice of a skilled investment advisor to ensure success with this strategy. The second scenario is best for those who have a difficult time managing their money or who'll sleep more easily at night knowing they have a plan in place to pay their loan off quickly.