Want to know something completely insane? Mortgages. Mortgages are the reason why it is great to invest in real estate.
Magic is an overstatement? No way! I have an investment that consistently returns me 66%/yr AND it’s close to risk-free! That’s what mortgages can do.
That’s financial magic.
Mortgages are the answer to:
- How to get into real estate investing
- Why it is good to invest in real estate
- Why I am so into real estate
Once you understand the numbers you will understand why mortgages are insane in a good way.
Completely. Insane.
So let’s learn:
Mortgage Magic in Action
To drive this home I will share the results from a real house that I’ve owned for 4 years to show that I’m not insane for loving mortgages.
Mortgage details:
- Home Price: $530,000
- Downpayment: $80,000
- LTV: 85%
- Rate: 2.8% (Easy number in Canada, where this house is)
The returns over 3 years:
My $80,000 investment 3 years ago has brought in:
- Rental yield over 10%/yr: Almost $30,000 in rental income
- Appreciation over 50%/yr vs. my downpayment
How could I not love something so profitable? *Heart emoji*
I know I had a good experience above but you will see mortgages are set up to create this sort of magical situation.
What makes Mortgages so Magical?
First off let’s walk through what a mortgage is so you can understand why this loophole in the financial world exists.
Mortgages are loans that you sign up for which are specially made for buying houses.
And there are two factors which make them special:
- Your bank will take your house away if you stop paying your loan.
- The government wants you to have a house, so they incentivize your bank.
Both of these are very important to create a special ecosystem for mortgage magic.
1 – The bank owns your house…That’s Great!
Okay, this sounds like it’s just great for the banks but it really is a reason why mortgages are fantastic because the banks love handing out mortgages.
Houses are generally good investments so if the bank ends up taking your house, it works out pretty well for them:
- They get the money you already paid them
- A house that’s probably worth more than what you borrowed.
Your house has more value than many other things they give loans for:
- Your dented 10-year-old Ford Fiesta. Worthless.
- A 10-year-old business that can’t pay the bills. Worthless.
A 10-year-old house though is pretty sweet. So this makes mortgages a relatively risk-free investment in the bank’s eyes.
2 – The government wants you to own a house
As a whole in North America, the government wants you to own a house and will help you out.
They don’t help you directly but they incentivize the banks by giving them insurance on your ability to repay your loan (eg. Fannie Mae).
This makes the banks LOVE lending to you.
If you stop paying they get:
- An insurance payout
- The money you already paid
- AND your house.
The banks really do always win but for us this is actually amaaaazing.
Banks will Fight over your Mortgage!
The banks who get a great deal
BUT this makes them compete for the honor of giving you a loan.
Then through the wonders of a free market, this competition creates fantastic deals.
The most important one is that the size of the loan is gigantic and the rates are low.
You can put as little as 5% down for a house and the bank will be happy to lend you the other 95% with a small interest payment.
Hundreds of thousands of dollars and they just met you!
If you tried to get this loan for a business or a stock investment, they would laugh at you. For a mortgage, “oh yeah, you can even get a discount.”
So why is it good to invest in real estate? You can get some ludicrous loans.
Do I really want a big loan? Oh yeah!
Getting a huge loan lets you make your investments extra effective.
Extra dangerous too, but extra effective for sure.
If you put $10,000 into a $100,0000 house and it increases by only 10% you just doubled your money.
- The value goes up to $110,000
- Sell it and keep $20,000 (ignoring fees)
- $10,000 on $10,000 = 100% growth
Magic! Not many investments allow for easy doubling!
I’ll illustrate this with a real example rental property which I borrowed from my friend Marco over at Norada Real Estate.
- $197,500 house
- Yields around $12,500/year
- Result = 6% return (ignoring any extras)
That’s a decent return.
Here comes the magic:
- You could put 10% down ($19,750)
- Still make $5,300/yr (assuming $7,200 interest at 4%)
- Return = 27%/yr
THAT is mortgage magic. 10% down is pretty aggressive though which takes us to the best part of mortgages…
Mortgages to match your personality
Making lots of money is nice but those are just calculations. Let’s talk feelings!
My favorite part of a mortgage is that:
You can choose how much of a loan you want on your house. So that it matches the house AND you!
- You are a conservative person?
- 50% down and never worry about cash shortages
- Want to be aggressive?
- 10% down and maximize your investment
- Found a house that yields a lot of cash?
- 20% down to maximize how many houses you can buy
Another way to look at it:
Any house investment can be made profitable with the right mortgage.
That’s awesome!
You can match your mortgage to your home. Mortgages allow real estate to match any type of investor mindset.
Mortgage Magic in Action
So we can adjust our mortgage to be whatever we want.
I’ll show how the numbers look when you adjust your downpayment size:
- Using a 10-year period
- 3% interest
- 4% for down payments of <20%
- $16,000 worth of repairs over 10 years (personal experience)
- $5000 of loan origination fees
So, we’re seeing two things as we adjust downpayment size:
- No mortgage maximizes total profit.
- Large loans maximize percentage return on investment
These numbers are really huge!
I want to point out how crazy these numbers are.
$20,000 results in 16% of your money back every year. That’s insane!
The historical average for a 100% stock portfolio is 7%.
People think 100% stock portfolios are too risky and this is double that! Magic!
A 10% downpayment might be too risky for you but you can choose the value that makes you happy (you can also try to mitigate the effects with other planning).
Why is it good to invest in real estate? A 5-6% return is pretty good but a 16% return is massive.
Oh, you want to reproduce this in the stock market? Good luck getting the bank to lend you $400,000 to follow a hot stock tip.
16% didn’t even include appreciation!
Houses appreciate and this gives the same money multiplying effect over again. So we need to include one more factor:
- 3.5% annual appreciation (Projected for this example Dallas house)
Blamo!
Wow! Percentage appreciation scales up as you get a bigger loan too!
It looks really beautiful when you combine rent and appreciation!
So why is it good to invest in real estate? That graph.
With only 3.5% appreciation you can get up to 30% annual return, my house from the start was increasing 10% a year (pure luck, I know) and it skyrocketed me to a 66% annual return.
Seriously a mortgage is probably what’s at the end of a rainbow, not a pot of gold.
Disclaimers!… Buy a good house!
I would be irresponsible if I didn’t mention debt can be dangerous:
- Save enough for repairs!
- Proper planning can make this all work out
- The sums are huge. Don’t go bankrupt.
- I recommend you get into real estate slowly. Even I’ve made mistakes by trying low income housing.
- If you buy a bad house the magic works in reverse too.
- Houses require work…but you can minimize it.
All the issues can be solved by finding a good house. So don’t get greedy and work the numbers out.
Good advice? I thought so too 🙂
This is my example of why it is good to invest in real estate. If you think it’s bonkers, it is. I wrote about this house and the ups and downs it has seen in my real estate portfolio article.
TL;DR – Why is it good to invest in real estate?
- Mortgages are special and let you get gigantic loans.
- Big mortgages can help you make lots of money.
- You can also adjust your mortgage to match your house/personality.
- Big loans can be dangerous so plan well
That’s is why it is good to invest in real estate but now it’s your turn! Do any of your love your mortgages?
Leave me the details in the comments!
You really didn’t give real life examples of your cost…. repairs, new A/C unit, etc cost to real estate agent to sell, property taxes, months where the house sat empty, bad renters who didn’t pay, etc.
That is true but I was trying to focus on the effects of mortgages here.
In the link in the case study (here for your convenience) I do go through 7 years of 7 houses’ expenses and income.
That’s the post that has all the good details you are looking for 🙂
Great post with some great info. I have 4 rental houses now and when i run the numbers I really cant believe the rate of return on them. It is unreal. On my first one, though, it took 10 years to see ANY appreciation and then it more than doubled in value in under 3 years… Also, this was our first home which we purchased with an FHA loan and put like 1% down. Just paid off this house about 3 months ago.
Yeah, great stuff Jace.
One of the big reasons I am into real estate is that if you can get through those first few years of horrible returns on a new rental, you will make it into the beautiful zone of rental cash flow machine.
I’ve tried a few types of houses and those first 1 or 2 years is always a pain. I wrote about it here:
https://fiveyearfireescape.com/real-estate-portfolio/
I read your post with interest, hoping to convince myself to try real estate investing. But, alas, for me, it all comes down to one line near the end: “If you buy a bad house the magic works in reverse too.”
I have owned three homes and up until the third and current one, I would not have thought that last line mattered so much. Real estate seemed safe until I bought this home. We’ve had very costly repairs and it has shaken my belief in my ability to ever confidently buy a home again. When we bought this house, me, my husband, our two realtors, and the home inspector all missed a serious foundation issue and in addition, virtually every system in the house needed costly repair in the first year (no one could really predict). A home has a LOT of variables and many costly items are in play. For me, the learning curve to understand, spot, and predict these issues is to steep and costly to overcome.
It seems like, at a larger scale, you could absorb this uncertainty and still come out ahead. But for the small investor, it seems way riskier than the numbers suggest.
Hi there, I’m sad to hear you had some hiccups, and houses are harder to get into than index investing, mostly because you need to have access to money for repairs like you spoke about.
I think you are missing out on one big feature though:
Housing is a long term game, the first year is crap, (read this) after 10 years that first year probably won’t even affect your returns too much (although foundational work sounds pretty rough). I have 0% confidence I can find a house that needs zero hidden repairs. I have near 100% confidence I can choose a house that will be lucrative over 10 years. 🙂