12 ms·

> Generally, with 20% down you are leveraged 5:1. So even if your home is just keeping pace with inflation of 3%, you actually experience 15% growth on your inv

by klipt 9y ago

> Generally, with 20% down you are leveraged 5:1. So even if your home is just keeping pace with inflation of 3%, you actually experience 15% growth on your investment. But if inflation is 3%, you're probably paying 3% (or more) interest on your loan. So suppose your home costs X. You pay 0.2X downpayment and borrow 0.8X through your mortgage. The first year your home appreciates to 1.03X but you also pay around 3% of 0.8X = 0.024X in interest. So your gain is 0.03X appreciation - 0.024X interest = 0.006X: which is exactly 3% of your 0.2X downpayment! Looks like the leverage didn't help in this scenario at all. Of course if you bought in the Bay Area a few years ago you made bank, but that's because the growth here happened to be much faster than inflation, even without leverage. > Sure, you can be leveraged in other investments but (1) your interest won't be tax deductible, (2) your interest rates won't be nearly as low, and most importantly (3) you won't be able to borrow with no recourse (3) is true, but you can buy stocks on margin, the interest is deductible as a business expense, and interest rates are often lower than mortgage rates.

phamilton 9y ago
That's fair. It definitely underscores the actual point of the article which is "You should run your own numbers rather than believe 'conventional wisdom'". I'd love to see some analysis (perhaps a monte carlo sim) on how the "no recourse" angle plays out. I can only assume that a floor on losses skews the expected outcome significantly.
- jo909 9y ago
  It underscores how little you should trust your own numbers (or numbers from strangers on the internet). Forget one small factor and the whole picture shifts a lot.
  - dspillett 9y ago
    > how little you should trust your own numbers. Forget one small factor and the whole picture shifts a lot. Though you should at least try run the numbers. Maybe you will forget an important detail but if you just go with your gut or an insufficiently specific recommendation from elsewhere you will likely miss many more important details. The trick is to do some research first, and if possible have someone else look over your thoughts to see if they can spot an important omission. Be particularly careful if the sums add up in a way that closely confirms your original idea - your analysis might be unintentionally biased by subconscious filtering. > or numbers from strangers on the internet That is definitely something to be wary of. Too many people base decisions on simple advice without checking that the advice is even relevant to their specific situation. I've seen people in the UK dump figures into US targeted calculators with the thought that "the $<->£ is the same for every figure so it will all work out OK" without thinking that our tax regimes and other factors are quite different in ways that can have a large impact.
  - rb808 9y ago
    Exactly - so if I buy a Bay Area house, what numbers do I put in? Will it go up 10% a year, or down 10% a year? I can see either happening. Certainly doesn't have much to do with inflation.
ProAm 9y ago
Your forgetting the tax write off of mortgage interest. Which needs to go into you equation no? That can be sizable.
- throw_away 9y ago
  Note that this will be capped at interest on a value of $750k for houses bought starting this year, so less than before. I think the leverage angle is ignoring the fact that your equity can be wiped as well in a downturn. It's unlikely my index fund will go to zero (and if it does, we'll probably have bigger problems on our hands).
  - phamilton 9y ago
    > leverage angle is ignoring the fact that your equity can be wiped as well in a downturn I call that out when talking about "no recourse". If you leverage 5X in the stock market and invest $1M in index funds and the market drops by 30%, you are on the hook for the $100k beyond your $200k you lost. If you leverage 5X in a personal residence and the market drops by 30% (and you live in a no-recourse state), then you mail the keys to the bank and walk away. Very unique situation.
    - dash2 9y ago
      > If you leverage 5X in a personal residence and the market drops by 30% (and you live in a no-recourse state), then you mail the keys to the bank and walk away. Very unique situation. But that seems dishonest.
      - Redoubts 9y ago
        Why? Lending is a risk on both ends.
      - phamilton 9y ago
        I absolutely agree it seems dishonest. But at the same time, it's in the contract. I'm aware of it, the bank is aware of it. They won't hesitate to foreclose on me if it's in their best interest according to the terms of the contract. Should I hesitate to take the action that is in my best interest?
AnthonyMouse 9y ago
> But if inflation is 3%, you're probably paying 3% (or more) interest on your loan. Not only that, leverage is risk. Buy a home in 2006, or in a city on the decline, and you may lose everything you put in. Leverage multiplies the losses as well as the gains.
s17n 9y ago
There's no such thing as a margin call on a mortgage.
- sokoloff 9y ago
  Not on a typical residential mortgage, but commercial balloon mortgages often have a provision for the loan being called early.
  - rsync 9y ago
    ... also many (most ?) seller-financed residential mortgages.
- refurb 9y ago
  There is in Canada! Mortgages have 5-year terms, but 30 year amortization. When you renew at the end of your 5-year term, the mortgage company can ask for an appraisal and ask you to cough up enough money to maintain 80% loan-to-value. That's even if you keep the exact same mortgage and bank.
hvidgaard 9y ago
What all professionals do, and what all potential home buyers should do, is run the actual numbers of expenses that is purely property taxes, interest, fees, expected maintenance, bills such as heating and electricity, and other related expenses not specifically reducing the amount of debt. That is the price of living in the house - compare that to renting a place. The difference between owning and renting expenses, is what you should compare to the risk/reward analysis of the property value.
- chatmasta 9y ago
  But with renting there is no reward. EDIT: In addition to mobility cited by a reply to this comment, another advantage is the saved opportunity cost of investment in real estate vs other markets.
  - scarface74 9y ago
    There is mobility.
    - k__ 9y ago
      Also, rents go up all the time, especially while moving into a new flat. If you rent a flat for 20-40 years, the rent won't change as much as when you move around every few years. So you might end up with super low rent compared to the rest of the city after 10 years or so.
      - scarface74 9y ago
        Rent control is only a thing in a few areas of the country. In most of the country, rent can increase at the end of a lease as much as the market will handle.
        k__ 9y ago
        Ah okay. I'm from Germany, where we have rent control everywhere. But I also know a guy from NY who rented a flat for a few hundred bucks decades ago and now subrents it to other people for thousands.
jonkho 9y ago
Leverage still outperforms fixed interest payments. Rising home prices compound on previous years’ appreciation. Your leverage rides on the back of this compounding. In contrast, your interest payments are fixed on the value of the dollars the year the loan was written.
- phamilton 9y ago
  Ahh... Great point!
- conanbatt 9y ago
  This was particularly true in the past, but i wouldnt bet much on this effect nowadays. Inflation is the true way to get this effect, but the dollar hasnt suffered inflation in decades. The new effect we have is asset inflation: sure you payed 3% for this house, but this house cost a lot more. When interest rates raise, mortgages are more expensive but house values go down. It is said that its better to buy in a high interest rate period at a low value, than a low interest rate at high value: in the former, you can re-fi later.

by klipt 9y ago

phamilton 9y ago

That's fair. It definitely underscores the actual point of the article which is "You should run your own numbers rather than believe 'conventional wisdom'". I'd love to see some analysis (perhaps a monte carlo sim) on how the "no recourse" angle plays out. I can only assume that a floor on losses skews the expected outcome significantly.

jo909 9y ago
It underscores how little you should trust your own numbers (or numbers from strangers on the internet). Forget one small factor and the whole picture shifts a lot.
- dspillett 9y ago
  > how little you should trust your own numbers. Forget one small factor and the whole picture shifts a lot. Though you should at least try run the numbers. Maybe you will forget an important detail but if you just go with your gut or an insufficiently specific recommendation from elsewhere you will likely miss many more important details. The trick is to do some research first, and if possible have someone else look over your thoughts to see if they can spot an important omission. Be particularly careful if the sums add up in a way that closely confirms your original idea - your analysis might be unintentionally biased by subconscious filtering. > or numbers from strangers on the internet That is definitely something to be wary of. Too many people base decisions on simple advice without checking that the advice is even relevant to their specific situation. I've seen people in the UK dump figures into US targeted calculators with the thought that "the $<->£ is the same for every figure so it will all work out OK" without thinking that our tax regimes and other factors are quite different in ways that can have a large impact.
- rb808 9y ago
  Exactly - so if I buy a Bay Area house, what numbers do I put in? Will it go up 10% a year, or down 10% a year? I can see either happening. Certainly doesn't have much to do with inflation.

ProAm 9y ago

Your forgetting the tax write off of mortgage interest. Which needs to go into you equation no? That can be sizable.

throw_away 9y ago
Note that this will be capped at interest on a value of $750k for houses bought starting this year, so less than before. I think the leverage angle is ignoring the fact that your equity can be wiped as well in a downturn. It's unlikely my index fund will go to zero (and if it does, we'll probably have bigger problems on our hands).
- phamilton 9y ago
  > leverage angle is ignoring the fact that your equity can be wiped as well in a downturn I call that out when talking about "no recourse". If you leverage 5X in the stock market and invest $1M in index funds and the market drops by 30%, you are on the hook for the $100k beyond your $200k you lost. If you leverage 5X in a personal residence and the market drops by 30% (and you live in a no-recourse state), then you mail the keys to the bank and walk away. Very unique situation.
  - dash2 9y ago
    > If you leverage 5X in a personal residence and the market drops by 30% (and you live in a no-recourse state), then you mail the keys to the bank and walk away. Very unique situation. But that seems dishonest.
    - Redoubts 9y ago
      Why? Lending is a risk on both ends.
    - phamilton 9y ago
      I absolutely agree it seems dishonest. But at the same time, it's in the contract. I'm aware of it, the bank is aware of it. They won't hesitate to foreclose on me if it's in their best interest according to the terms of the contract. Should I hesitate to take the action that is in my best interest?

AnthonyMouse 9y ago

> But if inflation is 3%, you're probably paying 3% (or more) interest on your loan. Not only that, leverage is risk. Buy a home in 2006, or in a city on the decline, and you may lose everything you put in. Leverage multiplies the losses as well as the gains.

s17n 9y ago

There's no such thing as a margin call on a mortgage.

sokoloff 9y ago
Not on a typical residential mortgage, but commercial balloon mortgages often have a provision for the loan being called early.
- rsync 9y ago
  ... also many (most ?) seller-financed residential mortgages.
refurb 9y ago
There is in Canada! Mortgages have 5-year terms, but 30 year amortization. When you renew at the end of your 5-year term, the mortgage company can ask for an appraisal and ask you to cough up enough money to maintain 80% loan-to-value. That's even if you keep the exact same mortgage and bank.

hvidgaard 9y ago

What all professionals do, and what all potential home buyers should do, is run the actual numbers of expenses that is purely property taxes, interest, fees, expected maintenance, bills such as heating and electricity, and other related expenses not specifically reducing the amount of debt. That is the price of living in the house - compare that to renting a place. The difference between owning and renting expenses, is what you should compare to the risk/reward analysis of the property value.

chatmasta 9y ago
But with renting there is no reward. EDIT: In addition to mobility cited by a reply to this comment, another advantage is the saved opportunity cost of investment in real estate vs other markets.
- scarface74 9y ago
  There is mobility.
  - k__ 9y ago
    Also, rents go up all the time, especially while moving into a new flat. If you rent a flat for 20-40 years, the rent won't change as much as when you move around every few years. So you might end up with super low rent compared to the rest of the city after 10 years or so.
    - scarface74 9y ago
      Rent control is only a thing in a few areas of the country. In most of the country, rent can increase at the end of a lease as much as the market will handle.
      - k__ 9y ago
        Ah okay. I'm from Germany, where we have rent control everywhere. But I also know a guy from NY who rented a flat for a few hundred bucks decades ago and now subrents it to other people for thousands.

jonkho 9y ago

Leverage still outperforms fixed interest payments. Rising home prices compound on previous years’ appreciation. Your leverage rides on the back of this compounding. In contrast, your interest payments are fixed on the value of the dollars the year the loan was written.

phamilton 9y ago
Ahh... Great point!
conanbatt 9y ago
This was particularly true in the past, but i wouldnt bet much on this effect nowadays. Inflation is the true way to get this effect, but the dollar hasnt suffered inflation in decades. The new effect we have is asset inflation: sure you payed 3% for this house, but this house cost a lot more. When interest rates raise, mortgages are more expensive but house values go down. It is said that its better to buy in a high interest rate period at a low value, than a low interest rate at high value: in the former, you can re-fi later.