You’ve done well saving money, and you now have a substantial amount to invest in—something. You can purchase certificates of deposit or dip your toe in the stock market, but you’re also considering putting the money down as a deposit on a home.
Is it a good idea, though? Aside from giving you a nice place to live that you can call your own, will your hard-earned cash grow the way it would in a financial institution?
Something that many people don’t realize is that if you use your savings to purchase a home, you are actually leveraging the mortgage to grow your money at a much faster rate. Let me explain.
Suppose you have $15,000 to invest. You do so wisely in some financial instrument, and over time you earn a 5% return—$750. Not too shabby.
Now suppose you take that same $15,000 and use it as a downpayment on a $300,000 condominium. Over time your home increases in value 5%, to $315,000. See what happened? Using the value of the condo you bought, you just earned a return of 100% on your original investment!
OK, there’s a lot of fine print here: you had closing costs, you paid property taxes and insurance, and you spent money maintaining your new castle, so your profit is nowhere near 100%. But whatever it is, it’s a heck of a lot more than 5% or whatever return you may have received from playing the stock market, unless you had invested in Microsoft when Bill Gates was barely old enough to buy a beer.
Here’s an actual story of a couple who moved to New York from Colorado in the early 1980s. Their parents encouraged them to rent and save their money, but they took a risk and bought a townhome for $75,000 in Staten Island, probably putting down about $3,750 or so.
Three years later the couple sold the condo for about $85,000, relocated to Edison, NJ and bought a bi-level for $119,000. It was a financial stretch for them, but they were confident.
Eight years later the couple moved again, to South Brunswick. They sold their bi-level for $195,000, and with a bit of help from their parents bought a brand-new colonial for $300,000. Again it was a financial stretch, but worth it.
Today that house in South Brunswick can easily sell for over $600,000. The couple weathered two real estate busts and other financially trying times, but their original investment of $3,750 (with an additional chunk from their generous parents) yielded a return of well over 500%.
I’m not a financial analyst or a lender. Speak to one before making a financial decision that will affect your future, but consider the leveraging effect that your savings can have on making you money as you enjoy living in your own castle.