Actually, that's not true. When people look at real estate, they should think about the total return. While long term appreciation of a median house has been something like 4.5%, once you include median historical rent it's comparable to SPTR.
Leverage is a separate question. I was just saying that most people think underestimate the total return of real estate (at least most financial literature does). And, considering the low volatility, using leverage makes sense. IMHO.
I once read that it is 3.1% real return since WW II. Granted the baby boomers were an incredible factor. But the fungibility of real estate, ease of getting loans, and worker mobility has changed a lot in the last 2 decades. So, I feel it will be more volatile for the future. So, paying of the mortgage is more of a capital budgeting and risk management decision. Nonetheless, I feel it is the no. 1 wealth builder for most households.
I was going to say that. If you are ABSOLUTELY able to earn higher return than how much you are paying on your mortgage then yes it makes sense to borrow to earn those higher returns. But the thing is this: You ABSOLUTELY have to make sure and are confident that you are ALWAYS able to make more than you pay in interest . At any time when you don't, you will be instantly losing money, earning less than what you were getting from any of your all-cash investment. It's because when you are investing all-cash, you owe nobody no thing. Whatever you earn, you keep. Whatever you lost, you lost. But when you borrow money, on top of what you lost, you actually have this burden on you to pay back somebody. I will illustrate with an concrete example : 1. Let's say you have an all-cash investment of $2000 earning 5% annual return. So at the end of the year, your end-of-year cash : 2000 * (1.05) = $2,100. 2. Let's say now you borrow another $2000 at 2% interest rate so your net investment at the end of the year on the $2000 that you borrowed would be: 2000 * (1+ (0.05-0.02)) = $2,060. In total, together with you all cash investment, your end-of-year investment proceeds just became: 2100 + 2060 = $4,160, a 100% increase This is all wonderful BUT let's say your investment return rate now falls below the borrowing int. rate of 2%: Going back to our example: Let's say on the $2000 that you borrowed, you were only able to earn 1% return: Since you still have to pay 2% interest so your end-of-year investment proceeds became: 2000* 1.01 (investment) - 2000* 1.02 = $-20 In total, together with your cash investment which we assume still earned 5%, your investment just became: 2,100 - 20 = $ 2,080. You actually lost money. And God forbid if you earn negative return on the money borrowed, then you would actually lose even more.
The ONLY thing that you should do with your borrowed money is to invest and NOT spend it because investing is the ONLY way where you can earn higher than your borrowing interest rate. If you borrowed to spend, that money is gone and you will always be making negative returns. To me renovation is spending. Yes you can say that it's a form of investment that will add value to your home but really when are you going to realize this investment? And what if the return of the investment which is your house when you sell it after the $200K renovation is less than the interest rate that you are borrowing? And yet you are on the hook to pay mortgage that you otherwise could've paid off every month, bi-weekly for another 30 years. As I illustrated before, anytime when you are making less return than your borrowing rate, you will be losing money. Looks to me that financial planner just wants to earn his commission from the mortgage financing. I wouldn't listen to him if I were you. I don't mind you refinance but you should only invest your proceeds in financial instruments ONLY if you are sure to be able to earn return higher than the borrowing interest rate but definitely not spending it like renovation and just spend the cash to renovate. Or if you feel you don't want the hassle of investing, then just pay off the mortgage and enjoy your house debt-free!! Good luck!
But if the financial planner really wants him to have some emergency cash around then he should ask him to cancel the renovation or go easy on the renovation to save some cash. Borrowing just to get some cash to spend doesn't make sense (We try not to do like what our governments do). Like I said that financial planner wanting to earn higher commission is more like it.
Borrowing money to make money makes sense ONLY if you are able to make more than you borrow. Borrowing money to spend money like credit card debt is what does NOT make sense. I will illustrate to you with an concrete example: 1. Let's say you have an all-cash investment of $2000 earning 5% annual return. So at the end of the year, your end-of-year cash : 2000 * (1.05) = $2,100. 2. Let's say now you borrow another $2000 at 2% interest rate, with the same 5% annual return, your net investment at the end of the year on the $2000 that you borrowed would be: 2000 * (1+0.05) investment - 2000 * (1 + 0.02) loan = $60. In total, together with you all cash investment, your end-of-year investment proceeds just became: 2100 + 60 = $2,160, an increase of 60/2100 = 2.9% !! This is all wonderful BUT let's say your investment return rate now falls below the borrowing int. rate of 2%: Going back to our example: Let's say on the $2000 that you borrowed, you were only able to earn 1% return: Since you still have to pay 2% interest so your end-of-year investment proceeds became: 2000* 1.01 (investment) - 2000* 1.02 (loan) = $-20 In total, together with your cash investment which we assume still earned 5%, your investment just became: 2100 - 20 = $ 2,080. You actually lost money. You made less than how much you made when you just had all-cash investment. Now third scenario, you actually borrowed to spend it all: So your borrowing interest rate still stayed the same at 2%, at the end of the year, you have to pay: 2000 * 1.02 = $2,040. But instead of investing it, you spent it all on this leather sofa that you always wanted, so at the end of year, your return on this borrowed $2,000 is: 2000 * (0) = 0 So in total, together with the $2000 cash investment, your total end of year investment becomes: 2,100 - 2040 (borrowed money plus interest) + 0 = $60!! A whopping $2000 investment that was earning 5% now just returned $60 basically wiping out ALL of its earnings!! This is WHY you NEVER borrow to spend, ONLY to invest so you would have a chance to make back some of the borrowing rate. And now you know WHY the American government is going broke because guess what they do with the money that they borrow?
[QUOTE="Llxa, post: 4406217, member: 378185" 2. Let's say now you borrow another $2000 at 2% interest rate so your net investment at the end of the year on the $2000 that you borrowed would be: 2000 * (1+ (0.05-0.02)) = $2,060. In total, together with you all cash investment, your end-of-year investment proceeds just became: 2100 + 2060 = $4,160, a 100% increase [/QUOTE] Errata: This calculation is wrong. The investment proceeds from the borrowed money at the end of the year should be 2000 * (1+ 0.05) - 2000 * (1+0.02) = $60 to match the next example where the return rate is less than the mortgage rate. So in this scenario, the increased investment would be: $2,100 + 60 = $2,160 NOT doubling the total investment proceeds, just a 2.9% increase, still higher than $2,100. Couldn't edit it anymore because it passed the 60 min. time limit
And who is the seer that knows that the money you borrowed will be on an investment with a positive return? What if, in your example, you borrowed money to make an investment and said investment went negative? So you have borrowed money to LOSE money, since you lost some of your initial investment, but are still paying interest on the original amount? It goes both ways. Makes no sense to me carry interest and OWE.