It would seem like common sense that if you had enough money to pay cash for a home, you would, right? Not so fast. Watch a recent interview with Warren Buffett on CNBC, explaining why he took out a mortgage in 1971 on a second home, even though he could have easily paid cash for the property.
Buffet's mortgage borrowing strategy can teach the average homebuyer a valuable lesson in the financial benefits of owning a home. Sometimes borrowing money, and thus incurring a debt, is a sound financial decision in the long run. In this case, Buffett used the money that he would have paid to own the house outright to buy more Berkshire Hathaway stock. With the cash, he saved taking out a mortgage on the house he put into the stock, which he says would now be valued at an astounding $750,000,000!
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Now not everyone can invest like Warren Buffett. Still, home buyers need to understand that debt is not always bad, particularly mortgage debt, because it may free up capital to invest elsewhere in investments that have a better return than the mortgage interest you are paying on your home loan. For example, if you take out a home loan for $100,000 at a 5.0% APR (Annual Percentage Rate), you would be paying about $5,000 in interest per year on that loan, less any principal payments you make during that year. But let's say that you have some student loan debt on top of buying a home where you are paying 6% interest and some credit card debt where you are paying 12% interest. These debts are much more expensive, and it would be better to borrow at 5% interest and pay down those other more expensive debts with extra cash while taking on the less expensive mortgage debt.
Over time you are saving the difference between the interest rates you are paying. Buffett also points out that if mortgage rates change, you can always refinance your home loan and take advantage of lower rates. If you already own a home with some equity in it and have a mortgage, you can apply for a "cash-out refinance" mortgage to extract some of the equity in your home and use that additional money to pay down more expensive debts or that cash into higher-return investments. This scenario shows how every homebuyer’s situation is different and that to select the right mortgage product, you need to consider your entire financial situation.
Currently, mortgage rates are still at historic lows, and almost all credit cards and some student loans will have higher APRs than a home loan, so it is worth considering. In the case of Warren Buffet, he was able to take that “$110 or $120 thousand” he borrowed and invested it into his own stock, which, over time, gave him a massive return. Also, his home appreciated over time; he was able to build equity in the home itself! They don't call him the Oracle of Omaha for nothing.
Mortgage loan officers can be quite helpful in giving you an idea if your loan makes sense. It is also a good idea to talk with your accountant to see any other tax benefits of borrowing money on a first or second mortgage.