Should you leverage your home or pay it down rapidly?
Posted by the Asbury Park Press on 02/18/07
BY WILLIAM BINTLIFF
There is a great debate within the inner-mortgage circles these days. Should loan professionals, encourage clients to borrow as much money as possible? Or would consumers benefit more if they understood the advantages of 15-year amortization schedules and pre-paying principal? Let's examine the pros and cons of both strategies.
Leveraging Property
In order to understand why someone would want to borrow as much as possible for a home purchase, they must first grasp 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 percent down, then they have $60,000 in equity. Over the next five 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.
A down payment has nothing to do with the rate of return. What becomes important is how one chooses to manage the $60,000 not used as a down payment. If it is used for frivolous activities, such as buying toys or going to Las Vegas, it would be more prudent to use that money as a down payment, especially since this will enables the buyer to obtain a lower interest rate.
However, investing the $60,000 in a vehicle that can out-earn the cost of that debt could be a formula for success. This is why some lending professionals suggest putting as little down as possible, maximizing your tax write-off, and investing the rest. This principle has been applied for many years in the life insurance game.
The old saying goes, "Buy term and invest the rest." The key component is taking the money that would have been used as a down payment and creating an asset accumulation account. This account should earn a significant enough rate of return to pay the mortgage off entirely and achieve the ultimate goal of being debt-free.
Paying Down Rapidly
There are very few times over the course of my career that I have seen a client with zero debt and no financial difficulties. Choosing to pay off all debt can reduce stress and help gain freedom of cash flow for investment opportunities. A 15-year mortgage or a biweekly payment strategy provides structure. It can also get the 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 the home is paid off, there's no greater rate of return than if it is paid it off slowly.
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. Over the course of time, it's been proven that the rate of return over the long-haul will be far greater than the rate paid 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 easier at night knowing they have a plan in place to pay their loan off more rapidly. Be sure that your budget can handle accelerated payments. When consumers "bite off more than they can chew" with a 15-year mortgage, they frequently end up having to refinance back into a 30-year schedule.
If you find this subject intriguing and would like to know more, I recommend a book titled, "Missed Fortune 101," by Douglas Andrew. It's an outstanding read that is very simplistic and goes into far greater detail than I can cover here. The author is a financial planner who advises safe-structured investments such as whole life policies and tax-free fixed income instruments.
William Bintliff is affiliated with First Interstate Financial Corp., a Licensed Mortgage Banker, New Jersey Department of Banking and Insurance. Fora free Consumer Credit Scoring Booklet, contact Bintliff at (888) 389-9878, Ext. 136.
BY WILLIAM BINTLIFF
There is a great debate within the inner-mortgage circles these days. Should loan professionals, encourage clients to borrow as much money as possible? Or would consumers benefit more if they understood the advantages of 15-year amortization schedules and pre-paying principal? Let's examine the pros and cons of both strategies.
Leveraging Property
In order to understand why someone would want to borrow as much as possible for a home purchase, they must first grasp 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 percent down, then they have $60,000 in equity. Over the next five 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.
A down payment has nothing to do with the rate of return. What becomes important is how one chooses to manage the $60,000 not used as a down payment. If it is used for frivolous activities, such as buying toys or going to Las Vegas, it would be more prudent to use that money as a down payment, especially since this will enables the buyer to obtain a lower interest rate.
However, investing the $60,000 in a vehicle that can out-earn the cost of that debt could be a formula for success. This is why some lending professionals suggest putting as little down as possible, maximizing your tax write-off, and investing the rest. This principle has been applied for many years in the life insurance game.
The old saying goes, "Buy term and invest the rest." The key component is taking the money that would have been used as a down payment and creating an asset accumulation account. This account should earn a significant enough rate of return to pay the mortgage off entirely and achieve the ultimate goal of being debt-free.
Paying Down Rapidly
There are very few times over the course of my career that I have seen a client with zero debt and no financial difficulties. Choosing to pay off all debt can reduce stress and help gain freedom of cash flow for investment opportunities. A 15-year mortgage or a biweekly payment strategy provides structure. It can also get the 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 the home is paid off, there's no greater rate of return than if it is paid it off slowly.
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. Over the course of time, it's been proven that the rate of return over the long-haul will be far greater than the rate paid 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 easier at night knowing they have a plan in place to pay their loan off more rapidly. Be sure that your budget can handle accelerated payments. When consumers "bite off more than they can chew" with a 15-year mortgage, they frequently end up having to refinance back into a 30-year schedule.
If you find this subject intriguing and would like to know more, I recommend a book titled, "Missed Fortune 101," by Douglas Andrew. It's an outstanding read that is very simplistic and goes into far greater detail than I can cover here. The author is a financial planner who advises safe-structured investments such as whole life policies and tax-free fixed income instruments.
William Bintliff is affiliated with First Interstate Financial Corp., a Licensed Mortgage Banker, New Jersey Department of Banking and Insurance. Fora free Consumer Credit Scoring Booklet, contact Bintliff at (888) 389-9878, Ext. 136.
Labels: Real Estate
posted by New Jersey Real Estate at 11:06 AM
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