The primary goal of most homeowners is to live comfortably in a home of their choosing for as long as they wish. They expect their home to be affordable and a solid investment that will appreciate in value. How can we make this goal even better?
The idea or expectation of “appreciate in value” naturally leads to a secondary goal: the creation of financial security and increased wealth. As homeowners progress toward retirement, they want their homes to increase in value, thereby providing enough money to live comfortably after retirement.
Being smart with your money can increase the potential for realizing these goals for security and wealth. But careful planning and strategizing must be in place at the time of your home purchase for the beauty of financial security to work its magic.
Arbitrage is a fancy word for being smart with your money. The word originally applied to the principle involved in purchasing a commodity, like currency, then simultaneously selling that commodity at a higher price, gaining an immediate profit. In other words, making a profit with little risk.
I use the term now as a method of borrowing and investing that will increase wealth for the homeowner. The principle of arbitrage in real estate is similar. It is realized by locking in a fixed cost of borrowing money to finance your purchase and then investing at a higher yield then the cost of a mortgage.
In the world of home ownership, most owners will mortgage a portion of the cost of the home and that is where a homeowner can “arbitrage” and increase wealth. As the impact of inflation, caused by government fiscal policy, ripples through our economy it will push up interest rates, home prices, and other commodities. However, with a fixed-rate mortgage, your payments will remain flat.
Let’s look at two home purchases. The first purchaser puts down $300,000 and finances $200,000 at 3.5 percent on the purchase of a $500,000 home in Santa Fe. The second purchaser puts down $100,000 and finances $400,000 at 3.5 percent and also buys tax-free municipal bonds at 4.5 percent with $200,000. I won’t bore you with all the calculations (call me if you want them), but after 10 years the same two buyers sell their homes. Let’s compare their wealth or equity at that 10-year mark.
Both homeowners are in the 30 percent tax bracket for federal taxes and deduct the interest expense each year for 10 years. The second buyer has the advantage of a larger deduction each year and the income on the bonds (tax free) accumulates over 10 years. The second homeowner creates far more wealth in this 10-year period and has a total of $410,000 in benefits from tax shelter, bond income, and equity in the home even after allowing for the higher payments of the increased mortgage. The first homeowner has accumulated $364,000 in total benefits. The second owner is $46,000 ahead.
Arbitrage is a great word. This is not a new formula and has been talked about for many years. Many homeowners are already using this wealth-accelerating method. Consult an investment person you trust and your tax accountant. The benefits of tax deductions, leverage and arbitrage are real.
Jim Gay was a real-estate broker for 20 years and has been a consultant to Fortune 500 companies. He is currently a broker/owner at The Mortgage Place, Inc. (505-986-9080) and can be reached at jim@tmplace.com
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June 07, 2020 at 01:00PM
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Mortgage Matters: Be smart with your money | Home/Real Estate - Santa Fe New Mexican
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