www.akerahomes.com
mfrentz@akerahomes.com
Remember: Please share this article if you find it enjoyable
Words Give Us Clues
Did you know that 'mort' comes from Latin and means 'dead' and that 'gage' comes from a French word meaning 'pledge'? In other words the origin of a mortgage means something like 'dead pledge'. Basically, if a bank lends money for a house and payments aren't made on time, their pledge to continue to give money is dead (they can take back the property to pay the debt). And if the house is paid off completely, the pledge to pay for the loan with the house is dead (there is no longer any debt owed). Either way, somebody's pledge/commitment dies when the situation plays itself out.
Why is this important for understanding mortgages? Because originally mortgages were never meant to allow somebody to take advantage of banks or other lenders. Instead they were a way that banks/lenders could take back something of value if the borrower didn't pay. That has changed a lot in the last 70-80 years. Many years ago a family could only borrow a small amount of the cost of the house (under 50%) and would have to pay off that debt within 3-5 years. Now a family, in Canada at least, can borrow up to 95% of the money needed for the house being purchased and can take 25 years or more to pay off that debt! With the big five banks (TD, RBC, Scotia, CIBC, and Bank of Montreal) they will typically lend, at the most, for 25 years at the time of this post. Other lenders (credit unions and insurance companies) will at times lend longer than that.
How Can A Mortgage Be An Asset?
First, it is important to understand that if you are investing in real estate that doesn't cash flow the argument I am about to make isn't as valid. I always recommend purchasing real estate that cash flows in order to cover risk. Having said that... What a mortgage allows a person to do now is borrow money at a certain price and pay that money back at a different, lower, price. I will give you an example to help make my point:
If inflation increases at 3% per year for the next 21 years we will pay $2 for something that costs $1 today. Have your parents ever told you about the time when they could buy a bottle of coke and a chocolate bar for 15 cents? The reason it costs more now is due to inflation. The reason inflation takes place is that our government makes money out of thin air (the more they make, the less valuable each dollar is because of supply and demand). Over time inflation DEVALUES our currency. So, those people who are keeping their money in a sock drawer or in the bank for long periods of time are actually losing money because their money is worth a little less each and every year that inflation takes place.
The way this effects a mortgage is that if you borrow $200,000 in year one and you have $100,000 left to pay in 21 years, that $100,000 that you owe is worth about half of what it is now worth. Another way to say this is that the you will still owe $100,000, but you will now be paying it back with money worth about $50,000.
I wish there were a really easy way to explain this, but I haven't thought of one that works really well. There are two key aspects to what I am attempting to explain. The first is that if you borrow money for a very long period of time, you will be paying it back when it is worth less than it is now which means it will be easier to pay back (it will be easier to earn $100,000 in 20 years because your wage will probably have about doubled). The second key is that all along the process of paying back loans you won't be paying it yourself, it will be the tenant who pays back this money. Because you will be making higher rent by that time, you will be putting more money into your pocket (if rent is costing your tenant $1,000 each month now, it's fair to assume it will have about doubled in 21 years and they will be paying you $2,000). So, if my mortgage payment is $600 each month now it will still be around $600 in 21 years, but I will be making an extra $1,000 from rent which goes straight into my pocket (the increase in maintenance costs won't be extreme enough to change this equation significantly).
Summary
This basic explanation of how mortgages work to our favor is that we can borrow at today's dollars and pay that debt back with future, devalued, dollars. When purchasing an income property it is sometimes wise to stretch the payment out as long as possible... that way you will be delaying the payment until you have more money to pay it back with. The only caution in all of this is that interest rates are at the lowest they have every been at in all of recorded history as far as I know. It is likely that at some point in time interest rates will rise significantly (it was only 35 years ago that interest rates for mortgages were over 20%). Always research what you want to do and how you want to invest and always connect with professionals in the industry in order to get an educated opinion before you invest, but then invest wisely and grow your wealth in so many ways because real estate is the most advantaged asset class on the planet!
Note: The main point of my argument above also applies to our family home, but only if we live in it for a long period of time. The average family is purchasing a new home every 5 years or so.... I'll cover why that's a terrible idea in a future post.
Here's to your future of risk-averse investing!
If you would like to learn more about investing in real estate please
contact me at the email address listed at the beginning of this article
or go to my website at: www.akerahomes.com/investing-in-real-estate.html
No comments:
Post a Comment