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There is an important oversimplification that these formulas/programs/spreadsheets often make, and I see it happening here. Consider two alternatives where everything is the same except the amount of money used for the mortgage down payment. The formula assume that money not used for the down payment is invested at a certain rate of return. If the mortgage interest rate is greater than the investment return, then the formula always indicate that the largest down payment possible should be made and if the rate of return for investments is assumed to be greater than the mortgage interest rate then the smallest possible down payment should be made. Its easiest to understand the problem with specific numbers. Assume a home buyer has $120,000 that could be put into a down payment, but that the minimum required is only $20,000. What should the buyer do? Assume that the investment rate of return is 5% and the mortgage rate is 4%. Investing the $100,000 instead of using it for the down payment is essentially borrowing $100,000 at 4% and investing it at 5%. All the formulas/worksheets/programs like this one and even professional investment advisors will end up showing that is better to put down the minimum down payment and investing the $100,000. This ignores the risk between alternatives. Putting the $100,000 into the down payment produces a guaranteed, riskless, return the buyer of 4% per year (by saving him or her the mortgage interest payments on the $100,000). The 5% potential return from investing the money isn't a fair comparison. The comparison needs to be made to a riskless investment (e.g. US Treasury Bills). Currently the riskless rate of return available to investors is approximately 0%. This means that in the current environment the correct alternative is to put the $100,000 extra into the down payment (absent any liquidity concerns). One may say that they are willing to take some risks to obtain a higher rate of return. Modern Portfolio Theory has its detractors, but as far as home buyers are concerned, its implications are still apropos. Having one component of your overall portfolio earning the equivalent of a riskless 4% (by making the larger mortgage down payment) is likely to produce better aggregate returns (on the home and additional equities etc.) at whatever risk tolerance one designs for their overall finances. I have no formal training in finance or investing so none of what I've described here should be interpreted as advice, instead it is intended to spur discussion. |
If I borrow at 4% and invest the same sum at 4%, then I'm guaranteed to lose money on the deal. How much more your investments have to yield, in order to break even on a loan-to-invest strategy depends on the degree of tax liability that your investments are subject to.