05 May Is it stupid to buy a house with debt (and live there)?
It is not uncommon for me to find a video (Instagram, Tik Tok, etc.) where a person (usually a self-proclaimed “financial expert”) explains why it is a bad decision buy a house or apartment, with debt, and live there. With arguments, often dubious but with great visual impact, this financial expert tells us that, basically, only a first-rate cretin goes into debt to buy his house or apartment… and live there.
At the same time, one leaves the smartphone and turns on the TV. In it, the financial system’s advertisements show us a poor child who lives very sadly, given that his family is constantly moving… the boy’s pity is that he cannot have friends. This advertisement concludes that with the help of the Bank (whatever it may be) he will finally put an end to his sorrows (including that of the boy) and help him fulfill the “dream of owning his own house.”
What is going on here?
Let’s start with one of the most used arguments: “Instead of paying rent, you pay the mortgage to the Bank and after a few years, you have your own house.” The logic seems solid… and it is, if it weren’t for those little details where that little devil lives.
Let’s start with the Bank’s offer. You get a mortgage loan for USD 100,000, for twenty years and an interest rate of 9%. I know that the conditions can vary, but for a moment, let me analyze this scenario.
After doing the math and the averages, a debt like the one I mentioned above means a monthly mortgage of USD 900; from which USD 417 is the capital amortization and USD 483 is the payment of interests, more than half of the mortgage is the payment of interest.
The composition of the monthly mortgage is shown in the following Figure:
What does the financial expert tell you? So instead of paying USD 483 in interest, you can rent an department or house with USD 417 and invest the rest. That is, you do something like this:
There is no doubt that the argument seems solid.
However, the analysis does not end here. We must know how you end up (in both situations) after twenty years (which is the term of the bank debt).
In the Bank scenario you start year 1 with a lot of hope and you reach year 20 as the brand new owner of a house, as shown in the following Figure:
In the scenario suggested by the financial expert, you invest USD 483 each month and if your investment has a return of 5% per year, then in year 20 you are the happy owner of USD 200,000. As shown in the following Figure. Not bad, huh?
So. Are those of us who go into debt to buy real estate (as the financial expert suggests) first-class cretins?
Not necessarily. Let’s go with the orthodox arguments.
It’s true, I have USD 200,000 at the end of twenty years… but can I buy a house with that USD 200,000? There is a factor of house prices that should be included in the analysis. Perhaps with that powerful USD 200,000 I can no longer buy a house like the one I want.
It’s true, I could have USD 200,000 at the end of twenty years… but what happens if I invest in the stock market and it collapses? In other words, there is a risk factor in the investment that I should consider. Although of course, there is also the risk that the house will collapse, but it is less likely.
Now let’s look at the arguments of behavioral economics:
If there is no obligation to pay the bank fee, is the human being organized enough to invest those USD 483 each month? This only works if you, instead of paying the fee to the Bank, invest part of said fee in a disciplined way.
Feeling the security of having your own house could give you more stability and, in this way, your professional performance could be greater.
Let’s look at the arguments of the family:
I cry because I have no friends (the son).
I’m tired of moving so much, I don’t even have fine furniture (the wife).
A house is a house (the father).
I don’t even know where you live anymore (the friends).
We have to settle down, son (the grandmother).
But let’s also give our financial expert a chance:
By renting a house we save on paying taxes. Ok, agreed.
The maintenance costs of the rented house are paid by the owner and not by us. Also agreed.
There is always the chance to change home or country, if things go wrong and even in that scenario, our investments are safe.
There is an offer of financial leasing… here I take a point off the financial expert, it is not necessarily like that.
At this point, the possible words of my Santi echoes in my head: “Well, dad, is it better to rent or buy?” (sometimes he loses patience with his dad). My answer is: Like everything in life, both options have pros and cons, it will depend on each person’s balance. Perhaps the only conclusion I come to, without digressions, is:
“Mr. financial expert, those who take out a debt to buy a house are not first-class cretins.”
Abrazo!
S. Mauricio Medinaceli Monrroy
May 5th, 2024.
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