How does leveraging a mortgage for profit work? How risky is it?
Does it work like this?
Here's my example: Let's say there's a house that costs $200,000 today. You pay all cash for it. In 5 years, the house's value increases by 15 percent per year and is worth $400,000. You've earned 100 percent return on your investment. Over 5 years, that's a 20 percent annual return.
But let's say you only put 20 percent down--$40,000. You borrow the rest. That means you have a mortgage of $160,000. In five years, the house is worth $400,000. Same scenario as above. But your investment--the money you had to come up with--was only $40,000. You've earned 500 percent return on your investment--$200,000 on a $40,000 investment. Over 5 years, that's a 100 percent annual return.
That sounds nice and all, but how risky is leveraging? And how do you find a house that actually goes up 15 percent in value annually? Also, regarding the second scenario, if your house's value increases that much and you have returned 100 percent, doesn't that mean you have
essentially paid off your home?
Take my word for it, no house appreciates 15% every year. So put the minimum down.
First, lets talk about your math. It's WRONG. Your initial investment was 40k. Now you have to factor in the monthly principal and interest payment on a 160k loan over a five year period, property taxes, insurance, maintenance, repairs and whatever it costs you to sell it (usually about 10% of the value of the home to sell). Your assumption of 15% increase in value year over year is also just plain WRONG if you look at historical averages over a long period of time.
What are the risks? Asset values fluctuate. You owe what you are contractually obligated to pay even if the asset is worth less than what you owe. Are you so very young that you do not remember the recent housing bubble that burst? People's homes lost half their value and it took YEARS to recover. Some still haven't.Source: allmortgage.net