Although many home-buyers do not realize it every home they buy has been bought with 100% financing. How can that be you may ask? The last home I bought I put 20% down.
It may be true that you took an 80% mortgage and used your own funds for a 20% down payment but what you may not realize is that the funds you used for a down payment was “borrowed” from your asset base that could otherwise have been used to earn a return on investment. Economists call this “opportunity cost”.
If cash-flow were not an issue then every home-buyer would be left to decide the optimal level of down payment and mortgage based on the return on investment they think they could earn versus the cost of borrowing the funds.
To demonstrate this concept lets assume that a family is buying a home for $250,000 and is deciding whether to put $50,000 down (20%) or $100,000 (40%).
-If they put $50,000 down they will take out a mortgage for $200,000 at 7.00% with interest-only payments of $1,166.67 (net after tax payment of $793). With the $50,000 that was not used for the down-payment they will invest the funds into an account that will earn 7.00% annually.
-If they decide to put $100,000 down they will take out a mortgage for $150,000 at 7.00% with interest-only payments of $875 (net after tax payment of $595). We’ll assume that they will use the difference in their net after tax payment ($198) to invest into an account that would earn 7.00% annually.
Here is a look at how these choices would perform over 30 years:
| Amount invested | $ 198 | $ 50,000 |
| Return: | 7.00% | 7.00% |
| Term (years): | 30 | 30 |
| Growth: | $ 241,554 | $ 380,613 |
As you can see the decision to invest the money upfront would net this family almost $140,000 more after 30 years.