Tale of Two Tellers - Part V
Do things change when you buy a house? It depends. While you wouldn't go to the teller for a mortgage, you are still ultimately borrowing from a banking institution at a 'rate' that you will repay to satisfy their current risk. Any time we borrow that 'rate' is a measure of the risk the lender is willing to take against their security of repayment. The security of repayment is in the 'asset itself' and the 'borrower ability and willingness to repay.'
Reminder: Any time we borrow, we are moving our future purchasing power forward to have use and control of something today that we either can't pay for with cash, or don't want to pay for with cash.
We said there are 3 things you can do with money you have: Spend, Save or Repay.
There is 1 thing you can do if you need money you don't have: Borrow.
Borrowing is always about need or want - we borrow when we need something we can't pay for in cash, or we borrow when we want to borrow to accomplish other financial goals (a future discussion).
Our client wants to buy $3,000 couch. They have an extra $500 a month in cash flow. They can save and pay cash in 6 months, or they can borrow today on a credit card, get the couch today, and because they pulled their future earnings forward they'll still have to pay $3,000 for the couch plus interest. They get the couch now, but it may take them 7 months or more of savings to pay it off with interest. They pay a premium to have it now, versus saving and waiting. When they pay if off, it is worth substantially less than what they paid for it based on depreciation.
Borrowing for a depreciating asset is not ideal.
Our clients wants to buy a $300,000 house. They could save and at $500 a month savings: $300,000 / $500 = 600 months = 50 years. That's assuming the house doesn't go up in value, which has never happened in history. When we want a house we really can't typically pay in cash, and we can't wait 30 years either as the house doesn't depreciate, over time it appreciates.
When we borrow for an appreciating assets that can be a sound financial strategy.
Banks do this all the time. They 'leverage up' and for every $1,000 in deposits they can lend $10,000 or more. They can also buy assets and leverage up a 1% return to generate 100% returns. Consumers can do this too, when they buy real estate.
A house buyer have the use and control of a $300,000 asset (the house) with as little as $15,000 in cash. This allows our consumer to save up to buy a house in a few years as they only need a portion of the asset price. They are playing the banks game, of using their money to control an asset that is likely to appreciate.
TIP: If you buy a $300,000 asset with $15,000 down payment, you have 20-1 leverage. When you buy an asset the appreciation (or depreciation) is of the assets. If the house goes up in value by 5%, that is 5% appreciation X $300,000 = $15,000 in new value. With a 20-1 leverage the 5% return x 20 = 100% growth. Your house is now worth $315,000 and you only invested $15,000. You now have a 100% growth return on your investment.