Leveraged Investing Carries Extra Risks.
Now, I'm not a real estate agent, but I think these are some key points to consider.
Every time I get a new client or update the information on a current one I have to provide a disclosure about leveraged investing, even if I’m not suggesting leveraged investing as a strategy! This is because borrowing money to invest carries extra risks. It magnifies both the returns and the losses.
Part of my disclosure reads: “If the investments go down in value and you have borrowed money, your losses would be larger than had you invested using your own money.” Your initial investment could disappear and you could end up owing money overall! Similarly, borrowing money in invest in your home means your return on your investment will be magnified and so will any losses.
If you invest your own $20,000 and the fund drops 50% in value, you only have $10,000 left. If you invest $100,000 ($10,000 of your own money and $90,000 borrowed) and your investment loses 50% if its value, you now have an investment minus loan value that equal you being $40,000 in the hole. While I’m not predicting a 50% crash in Vancouver real estate, it would only take a 10% drop to erase all of a 10% down payment.
Sure, you still get to live in your home if it’s worth less than your mortgage, but it really ties you down. In the US housing crash in 2007-2008, people ended up unable to move to find better job prospects because selling their home wouldn’t leave them enough money to pay off the mortgage and they didn’t have the spare cash to pay back the loan.
And what about refinancing your home or renewing your mortgage? You might find yourself in trouble if your leveraged asset isn’t worth enough at the end of your mortgage term.
Sometimes, it’s worth it to think about a mortgage like credit card debt: just because someone is willing to lend to you doesn't mean you should run your limit up to the maximum.
Check back next week for the next installment in this real estate series: Diversification is Key. You can also drop me a line to hear more.