Why you should use a mortgage even if you have enough cash
The Sterling ReportSunday, July 25, 2021
BY MARIAN ROSS
Real estate is a popular component of most investment portfolios. Indeed, it is important to own one's home and many investors use it as a store of value. In many cases, “mature” investors seek to purchase starter homes for their children or grandchildren as a means of passing wealth across generations. There is always temptation to purchase these properties using “cash” or “equity” ie, to give their children a property that is free and clear of debt. However, very rarely are these investors considering the opportunity cost of the funds they use to purchase the property.
Think of the mathematics:
1. Cost of average Jamaican dollar mortgage: ~7.5%
2. Average annual Jamaican dollar devaluation over the past 18.5 years: ~6%
3. Cost of Jamaican dollar mortgage in US dollar terms: ~ 1% - 2%
4. Historical growth rate in a US dollar mutual fund: ~ 11.9%
This is a back-of-the-envelope calculation and is not meant to represent sophisticated finance. However, the principle is important to note. The cost of a mortgage in Jamaican dollar terms may be 7.5%. If devaluation averages 6% per year, then in US$ terms, the cost of your mortgage is about 1.5%. This means that if you can earn more than 1.5% on your US$ investments, you are financially better off using a mortgage.
The money you use to buy the property would be part of your “long term” investment portfolio. Therefore, the US$ investments that are comparable to the property would also have to be “long term” in nature.
The longer the horizon of the investment, the higher the returns. Therefore, the opportunity cost of using your “liquid” investments is so high. Instead of buying a property – think of mortgaging it and using your idle US$ funds to make longer term investments. The current interest rate regime in Jamaica makes it more economical to use a mortgage and keep your long-term US$ investments or even your JM$ stock market investments. The math has never been more attractive.
Investors looking to give their children property would be wise to use their liquid investments to help with a larger than average down payment and help the child take out a mortgage that he/she can comfortably service. Not only does it teach a lesson in prudent financial management, but it creates a larger nest egg for the child to inherit further down the road.
Marian Ross is vice-president, Trading & Investment at Sterling Asset Management. Sterling provides financial advice and instruments in US dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm
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