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.

Wealth Through Real Estate, Be Prepared

There are more millionaires created through the ownership of Real Estate than any other investment. If you were fortunate enough to own Real Estate over the past few years, you have seen a dramatic rise in your wealth. The more you owned the greater the gain.

Real Estate will continue to rise in the long term even if we do see a market correction in the short run as many anticipate. Today may not be the time to jump in and buy investment homes due to the volatility of the market today, but it won’t be long again before home prices stabilize and it is time to start buying again.

My suggestion would be to get your funding in order to be able to step in and take advantage of the opportunities of a soft market. Those able to react fast will be the ones that will benefit the most when the landing is over and the market is again taking off.

Some ways to prepare would be the use of the home equity in your primary residence to purchase other real estate. Credit lines may be right for some while others will find value in cashing out by refinancing into a larger first mortgage.

When values are low is the best time to move up.

If you are considering moving up, now may be the time. Although you may have to be aggressive in the sales price of your home to sell it, bear in mind that there are a lot more homes available to buy now, also at discounted values.

If you assume that you would have to sell a $250,000 home at 10% off for $25,000 less that you anticipate, also know that you would be able to buy a $500,000 at 10% off for a saving of $50,000, netting you a savings of $25,000.

If you wait until the market is hot again, there will be less homes to choose from and your likelihood of finding a bargain are slimmer. So, go out with your Realtor and take a look around first to confirm that it is a true buyers market for the homes you desire, then get your home on the market at an aggressive price. It’s a buyers market, take advantage of it.

Remember the Rule of 72s

The rule says that to find the number of years required to double your money at a given yield; you just divide the yield into 72. So if a home is gaining 6% per year, 6 divided into 72 equals 12 years.

With 6% being about the average appreciation of housing over the long run, that means that if you own a home today worth $500 Thousand, twelve years from now the home could be worth $1 Million for a gain of $500 Thousand!

With today’s tax law, for a married couple that gain is TAX FREE! There is no better investment that your own home, not your 401K, IRA or any other investment available.

Interest Only-It's Just An Option

'Interest only' is just an option that is added to many loan programs. It allows a customer to determine when they want to pay the balance of a loan instead of requiring the payoff through amortization. It is a nice feature to add to a loan to minimize the required payment each month. Interest is what a borrower pays a lender as compensation for the use of the money over a specified period of time. An interest only loan requires a payment that pays the interest that has accrued on the loan, but with no principal reduction required for a specified time frame. Interest only products offer a way to lower monthly cash flow, but do carry some risk and must be evaluated to make sure they fit for the particular borrower. They are ideally suited for the borrower who can use the lower cash flow to maximize financial leverage by pursuing other financial opportunities.