Summary
Why do you think someone who could buy a home upfront, and in cash, would opt to still have a mortgage to pay?
Simple! That cash can grow!
Why would someone who makes millions of dollars per year, and could easily pay for their house in cash, still have a mortgage? Said another way, why do rich people feel so strongly about taking on six-figure ($100k+) debt and paying six-figure amounts of interest?
I’ll reason through the logic below, but the short of it is: wealthy people would rather take on lower interest mortgage debt so they can keep cash available to invest in stocks and other wealth-producing investments. See my spreadsheet here.
Let’s take an example:
You can buy a house in cash for $300,000. Or, you could put $30k (10%) down and get a 30-year fixed mortgage for $270k at 4.5% interest, allowing you to invest that $270k in a stock market index fund for the same time period.
The average long-term return of the stock market is 10.5% per year, while homes increase on average 4.52% per year. That doesn’t tell the whole story though — you benefit from your home’s increase in value whether or not you have a mortgage on it.
If you took the mortgage, 30 years later you’d have $2,700,000 more money than if you paid for the house in cash!
That’s true even though you paid over $200k in mortgage interest. But, what if the stock market performed much worse? Even at an average return of 6% per year, you’d still be $250,000 richer with the mortgage than without. Check out my spreadsheet to see more.
Cautionary note
These stock market and housing returns are averages over the long term. Looking at the last 20 years, the S&P 500 Index had a decline of 10% within a year in 10 out of 20 years but ultimately had positive returns in 17 out of 20 years. From 2006-2011, housing prices dropped about 30%. No one can predict the future, but the best, most consistent investors think long-term: time, not timing, matters.
In our next post, I’m going to write about why smart homeowners care about home equity and not just home value.
