Financial Leverage: Mortgage yay or nay?
This month’s topic is about leverage. Whether leverage comes in the form of a mortgage or trading on margin, I want to share my opinion on my evolving perspective of using financial leverage, and why that’s necessary to not only stay ahead with inflation but sometimes is the only solution to staying at par with inflation.
Yes, that’s the dreaded “I” word that we all can’t avoid and especially detrimental to us savers, but it need not all be dreadful.
Disclosure: I don’t have any leverage at the moment, but now I can see why that it’s important if you want to get ahead.
Mortgage vs Margin
There are mainly 2 forms of financial leverage available to us common folks at the individual levels: 1. mortgage, and 2. trading on margin.
Both methods use the same principal of borrowing to amplify the returns on your initial capital. Although opt 2 is more risky IMO as your capital falls below the allowable threshold and you get a margin call. More reading available here.
Essentially everyone needs to live somewhere and always a hot topic of discussion. Hence I want to examine option 1.
Lets say for example, you buy a home for $500K with a 20% down payment of $100K.
When the home goes up in value to $600K, you just made a 100% return on your investment (minus realtor fees, and in Canada, capital gain on principal dwelling is tax exempt).
Scenario 1: the home value could go down as we saw in Alberta, Canada in 2014 if you had bought right at the peak. Now you are under water and must wait it out. Hopefully, you still have a job, or have means to keep making payments, or you are SOL.
Scenario 2: The value of the home stays the same. Congratulations, you have a roof over your head. Rent vs buy cost benefit analysis really comes down to individual scenario.
Scenario 3: Lost opportunity cost, from funds that could be instead invested in the market for an annual 8% increase. But let’s not forget here, everyone needs somewhere to live.
The Best Coast Miracle
One thing we can be sure of though (along coastal cities in North America from Vancouver to San Diego), there will always be a demand for housing from both domestic and international buyers. Every time you think there will be some tiny correction on the horizon, there will be tons of people waiting to jump into the market. Nesting, is simply a human instinct – not driven by logic, rational, or finances. So for better or for worse, we can have relative certainty that North American coastal cities will continue to stay expensive for the foreseeable future. Why the west coast of North America you ask? Because it is beautiful. That’s subjective. It’s also one of the more liberal, democratic, clean, and politically stable parts of the world. It’s no coincidence, that we were nicknamed the Best Coast.
Of course, at the end of the day, the best solution to easing your cash flow and keeping a roof over your head, might just be to pay 100% in cash. But what kind of local domestic earner has that kind of means aside from the wealthy “foreign investors”? And if one had the means to pay 100% cash for their primary dwelling without eating up their entire net worth, would one even be reading this article?
Can one leverage and still get a good night sleep?
I would say, yes, even with a mortgage, one can still be on the road to better sleep. After all, one of the main pre-requisites to a good night’s rest is staying dry with a roof over your head. If you do the math and find that you are more ahead mortgaging than renting, then may be that is the option for you.
So mortgage yay or nay? At the end, it’s a very personal decision. 2 people could be living and working in the same city, with very different circumstances, so there really is no one size fits all. Here’s a rent vs buy calculator to help you out