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(Originally Published on - 2/12/2016 12:26:05 PM)
Let’s say that you just won $8,750 on a lottery scratch-off ticket. You’ve decided to be frugal and invest the money and have decided on three alternatives: buying a certificate of deposit, a mutual fund or use the money as a down payment for a $250,000 home.
To compare the three alternatives, let’s look at the equity in each one three years from now.
The certificate of deposit can be invested at 1.3% in today’s market and you believe you can reasonably earn 5% on a mutual fund. You expect the home to appreciate at three percent a year.
The certificate of deposit would be worth $9,096 at the end of three years and the mutual fund would be worth $10,129. However, the equity in the home at the end of three years would be $45,204. That is a four time’s higher yield on the home.
One of the main reasons for the big difference is that the buyer benefits from leverage: the use of borrowed funds to increase the results. The $8,750 down payment is controlling a $250,000 investment. The appreciation is determined by the price and not merely by the cash invested. Another factor is that the loan balance is smaller at the end of five years than originally borrowed due to amortization.
There are certainly other factors to consider such as maintenance and other expenses but when the financial benefits are as strong as they are, it certainly deserves a much closer investigation. One of the first things to consider is whether the borrower can qualify for a mortgage and the only satisfactory way to be certain is to get pre-approved by a trusted mortgage professional.
Use the Your Best Investment calculator to make your own projections.