A home purchased for $400,000 will appreciate to $420,000 in one year. If the homeowner originally invested $80,000, or 20%, the ROI is 25%. This is true because the initial $80,000 downpayment yielded $20,000 in equity appreciation.
If the homeowner had not invested the $80,000, the home would still be worth $420,000 in one year. In this instance, the ROI is infinite. However, we must take into account the rate of borrowing will be higher in this example. With a 7.00% HELOC drawn on the $80,000, the payment will be $5,600 in Year 1. The second example yields a return of at least 357% because the $5,600 additional payment yielded $20,000 in returns.
There are other ROI considerations for the homeowner. A home is an non-liquid asset meaning once the homebuyer's money is invested in the home, there is a real cost to extracting the money as cash. The initial $80,000 investment, therefore, is "lost" -- tied up in equity until the homebuyer sells, refinances, or opens an equity line of credit. Not only is the initial $80,000 investment earning 0% return for the homebuyer, it is unavailable for other investments which could be earning 4% as a Money Market Fund, 5% as a Certificate of Deposit, or even higher returns with other instruments. Therefore, the opportunity cost of making a downpayment is further depleting ROI for homebuyers.
A "conservative" person will read this argument and say, "That's too risky. I am too conservative for 100% financing." I can buy that argument, but those two sentences are not related at all.
A true "conservative" person will recognize that with 100% financing, the only party taking a risk in the transaction is the bank. The homebuyer has absolutely nothing at stake! "What if the property depreciates!" they'll say. Well, if the property depreciates, there is no advantage to your initial equity investment anyway, right. I'm sorry, but Out of sight, Out of mind is no way to manage your equity investments and finances.
The reality is the conservative financing option is 100% financing. You have pushed all risk to a third party -- the bank! In doing so, you remain completely liquid -- the true goal of a conservative investor.
I am not arguing against making downpayments on properties. But, for people who claim Real Estate is an investment, they should treat it as such. This is consistent with my philosophy that a mortgage should be one component of a larger (managed) financial plan. The advantages to making an equity investment in property is the resultant monthly mortgage payment is lower. If monthly cash flow is low, but investment capital is high, there is an argument for putting 20% or even more into the property. There is also tremendous psychological inertia to overcome with respect to putting less than 20% into a property. Some people just won't hear it any other way. That's fine -- diff'rent strokes for diff'rent folks!
