An acquaintance of mine thinks a home mortgage is the best deal on the planet: “Look,” he says, “The bank loans you 80% or more for the purchase price of a house. Then you pay them back in funny money for the next 30 years. In the meantime, you get the appreciation on the entire value of the house.”
By “funny money,” he meant that, every year, the fixed mortgage payment will be worth less and less due to inflation. And, hopefully, the borrower’s income will rise over time. By the time that mortgage is paid off, the home payment will be a much smaller slice from the budget pie than at the start of the loan.
Boy, mortgages do sound appealing when they’re described that way. But bankers aren’t in the business of losing money (that would make the Federal Reserve cranky). In reality, the interest rate on a mortgage is high enough (most of the time) to account for inflation, so there’s no “funny money” business going on. It is true about the home buyer getting to keep all of the appreciation on the home. I’ll remind everyone here that the borrower is also exposed to all the potential losses.
Give or take a few financial crises and bad real estate deals, much of the post-World War II American Dream was built on home ownership and the ease of borrowing money. Bank shareholders also benefited (again, usually) from the arrangement. You see, banks only need to hold a small percentage of deposits available for immediate withdrawal. They loan out the rest at a higher rate than the interest rate they pay on deposits. They’re borrowing money too, but from their depositors.
So the home buyer only puts a small amount of money down to buy a house, and the bank only has a small amount of money on deposit compared to its loan. The takeaway is that debt isn’t automatically bad. Companies borrow money to stock inventory or expand their businesses. People invest in themselves to further their careers or to buy appreciating assets.
Debt is only harmful when you borrow money and get little in return. We financial professionals get the twitches when someone goes into credit card debt for a fun night on the town. But, If you can borrow money at a low rate and invest it for a much higher return and can live with the possibility of the arrangement going wrong, consider it.
Just be sure to factor in every conceivable cost and risk before you pull the trigger. There are few, if any, free lunches in the markets, and you won’t be paying the bank back in “funny money.” Some people hate the additional risk of taking on any debt, or they have no interest in owing anyone any money. That’s okay, too.
Once in a while, there are risks worth taking. For most of us, those opportunities are few and far between. But, when those chances land on our doorsteps, debt can become a servant instead of a burden.
Evan R. Guido is the Founder of Aksala Wealth Advisors LLC, a 2018 Forbes Next-Gen Advisors List Member, and Financial Professional at Avantax Investment ServicesSM. Evan heads a team of retirement transition strategists for clients who consider themselves the “Millionaire Next Door.” He can be reached at 941-500-5122 or eguido@aksalawealth.com. Read more of his insights at https://finance.heraldtribune.com/category/ask-guido/. Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM, Insurance services offered through an Avantax affiliated insurance agency. 6260 Lake Osprey Dr. Lakewood Ranch, FL 34240. The views and opinions presented in this article are those of Evan R. Guido and not of Avantax Wealth ManagementSM or its subsidiaries. Past performance does not guarantee future results. The S&P 500 is an index of 500 major, large-cap U.S. corporations. Standard & Poor's is a corporation that rates stocks and corporate and municipal bonds according to risk profiles. The S&P 500 is an index of 500 major, large-cap U.S. corporations. You cannot invest directly in an index. An investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund. CDs are FDIC insured and offer a fixed rate of return. They do not necessarily protect against a rising cost of living. The FDIC insurance on CDs applies in case of insolvency of the bank, but does not protect market value. Other investments are not insured and their principal and yield may fluctuate with market conditions. Investments are subject to market risks including the potential loss of principal invested.