I just sold my house a while back and am looking for another house. My intentions were to just pay cash for the new place. Now the bank is trying to get me to take out a new mortgage with them and their mortgage advisor says it’s crazy to spend all cash on one big purchase like a house when I could put 70% down on the house, get a mortgage to cover the remaining 30%, and save some of my cash for other investments. All my life I was told debt is bad, now I am questioning this.
I have a few thoughts on this situation and the advice you’ve been given, both by the bank employee and the people who told you debt was a bad idea.
First, I agree that debt is usually something to be avoided. Any time you’re going to end up paying interest on money you’ve borrowed, it is increasing the cost of your purchase. When you use a credit card to cover small purchases and pay it off at the end of the month, you don’t end up paying interest due to the card’s grace period. This makes short-term credit card purchases okay in my book. However, car loans, big credit card purchases you can’t pay off right away, and other long-term loans have a habit of getting expensive.
Some debts are worth it. Going into low-interest debt in order to purchase a home for your family or to go to university can be well worth it. However, purchases which put you into debt should be considered carefully and avoided as much as possible, in my opinion. The interest on multiple debts can quickly increase your cost of living. They can also narrow your travel or career options because you need to be thinking about paying your debts and may not be able to take jobs or opportunities which don’t provide a stable income.
All of this is to say, I agree that debt is usually something to be avoided. But in some special circumstances, can be beneficial.
The second point I’d like to make is that the person telling you to take out a new mortgage on your future house is a mortgage advisor. In other words, their job is to get you to take out mortgages. It is in their best interest to push you to get a mortgage, whether you need one or not. A mortgage advisor is not a neutral third party. This isn’t to say the mortgage advisor is malicious, but it is in their interest to sell you a new mortgage and they will likely present arguments which correspond with their interests in a favourable light. Keep this in mind when evaluating their advice.
Third, when considering advice (whether giving or receiving it) context is key. An example I like to use is this: Telling someone to open up and share themselves more is great advice to give to a wallflower at a party; it’s not great advice to give a loud, drunk person who won’t stop talking loudly about politics. The same advice at the same party can have entirely different results, depending on to whom you give it.
In this scenario you’re being told that it makes sense to take out a mortgage on your new house and put some of your savings into investments. The idea being that if your mortgage’s interest rate is low and the stock market performs well, then you’ll be earning more money from the investments than you’re paying on the mortgage.
This idea of borrowing money at a low interest rate and using it to invest in stocks which will (hopefully) return a better rate is a common one and it has a certain appeal. After all, if you’re putting your money to work for you and it’s making more than your interest payments, then you’re getting free money, right? Well, maybe. I talked about this in an earlier post about borrowing money to invest. In short, there are three main problems with this idea which can come back to bite you.
- The income from your stocks could go down (perhaps due to a recession).
- Your mortgage interest rate could go up.
- You might get taxed on the stock income enough to not make it worth going into debt.
The first two are the important ones. When mortgage rates are low and the stock market is climbing, it makes a lot of sense to use a mortgage and invest your savings. When you’re making mortgage payments at 2% interest and your stocks are returning 10% growth, it’s a clear advantage to borrow money to invest.
However, if your mortgage has an interest rate of 8% you’re trying to pay down and the stock market is dropping at -10% then you’re losing money in investments and in your debt payments. In this case it’s a terrible idea to borrow in order to invest.
In other words, timing is the key bit of context. If someone told you to borrow using a mortgage to buy stocks in July 2020 you’d probably be paying your mortgage at less than 2% and making returns in the stock market at close to 20% for the next year and a half. That would be wonderful! However, if you tried this same trick at the start of 2022, then your mortgage rate would probably be closer to 5% and your stock returns would be -15%. In other words, if you’d taken out a mortgage for $100,000 in January 2022, then you’re probably have $85,000 left now, minus your mortgage payments.
Now the stock market will probably recover, eventually. And it might turn out to be worth your efforts to invest with your savings while paying a mortgage. On the other hand, you might finish paying your mortgage before the market recovers, in which case you’ll be out the amount of your mortgage’s interest payments. It’s hard to tell the future.
Personally, I think your gut instinct is a good one. Taking your bank’s advice might put you further ahead, but it’s a gamble. And you might end up further behind, at least for the next few years. On the other hand, if you pay for your new house entirely in cash and avoid the debt, then that gives you more flexibility in what to do with your finances in the coming years. You won’t be tied to a mortgage or worrying about your relative rates and investment returns.
In short, avoiding debt means less risk and more flexibility. It means you might miss out on a small investment opportunity, but buying your house outright also means no losses if the market continues to move against you. My instinct would be to take the safe and stress-free option over the possibility of the market recovering in time for investments to pay your mortgage interest, plus a profit.
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