Yes, There is a Right Time to Take on Debt for Your Luxury Home
For wealthy homebuyers, current low interest rates and refinance deals can prove fruitful investment strategies
“Cash is king,” the old maxim goes. And when it comes to luxury real estate, it’s true that cash transactions are a popular way for high-net-worth homebuyers to obtain sumptuous properties around the globe. It can lead to smoother, faster deals and win bidding wars.
However, there are some instances when taking on debt to finance a multimillion-dollar home—even when the cash to buy it outright is available—can actually prove more fruitful in the long run.
So what should homebuyers think about before making an offer on that dream country estate or waterfront villa?
First and foremost, they need to consider the available interest rate on a mortgage relative to the return they are getting on their other current investments. When average interest rates are low—between 3% and 4%—as they are now in the U.S. and have been since the recession ended, a wise move would be to take out a mortgage and let their liquid assets work for them elsewhere, moving them into stocks, bonds, private equity or some other investment.
“It the buyer can obtain a mortgage at 4% and is earning 10% return on his investments, it makes sense in many cases to leave the money sitting in his investments,” said Robin Kencel, a broker at Compass’s Greenwich, Connecticut, office.
These days, it’s quite likely a qualified buyer can find a low interest rate on a home mortgage loan. At the end of March, mortgage-finance giant Freddie Mac reported the average rate on a 30-year fixed mortgage fell to 4.06%, the lowest since January 2018 and the (falling from 4.28%) in a decade. The rate has since crept back up, barely, to a still relatively low 4.08%, as of Freddie Mac’s most recent April 4 report.
Smart Leveraging Can Create Big Returns
A really savvy homebuyer with cash on hand—and energy to spare on some serious strategizing—might take advantage of the current rates and embark on what’s known in the finance industry as “leveraging,” or a way of using borrowed money to build potential returns from an investment over time, said Harry Chernoff, a clinical professor at New York University’s Stern School of Business and a long-time real estate developer.
If someone has $3 million in cash, for example, they could distribute it as three $1 million down-payments on three properties each worth $3 million, then mortgage the rest, Mr. Chernoff said.
“What you end up doing is owning $9 million worth of property and if the investments are … stable and managed well and all of the risk has been considered, this leveraged factor gives you a way of building a lot more,” he said, with potentially higher returns.
Of course, multi-prong real estate investments such as these should be carefully planned with a financial adviser who can help track home appreciation trends in specific markets and assess tax implications, experts said.
Borrowing for a Second Home Purchase
Another time when it makes sense to borrow money rather than buy outright is when shopping for a second home. In the ideal scenario, the owner has held their current property for a number of years and it has gained value over time, but they aren’t ready to sell, Mr. Chernoff said. Instead, they could refinance the property—again, taking advantage of low interest rates if possible—and take out a home equity loan against its value. That produces cash that could be used as a downpayment toward a second home.
"They know they have a value there but they kind of think they're never going to realize it until they sell it," he said. But “when it has appreciated and you can do a refinance, you can get a tremendous benefit.”
In general, strategies like leveraging and refinancing apply across the board, whether a homebuyer is located in the U.S. or abroad; consideration should be given to specific international interest rates, of course.
“Most of the concepts would apply anywhere,” Mr. Chernoff said.
Some ultra-high-net-worth homebuyers will alternatively use refinancing as a way to take out the initial mortgage on a new home after purchasing it in cash, said , a capital adviser at BMO Family Office, part of BMO Wealth Management in Chicago. Ms. Peel works with ultra-high-net-worth clients, including international residents who are looking for housing in the U.S. (She defined “ultra-high-net-worth individuals” as those with $30 million in liquid assets or an overall net worth of $100 million or more.)
The strategy is useful when Ms. Peel’s clients have made an offer in a particularly competitive housing market or when there is a tight closing window of one or two weeks, and they need to get the deal done, she said.
“At least 85% of them choose to borrow to finance a home purchase, and they may pay cash up front, depending on how hot the market is where they’re purchasing,” she said. “Then they would typically do a cash-out refinance on the closing of the home.”
The process enables the ultra-rich to “redeploy their capital” into a diverse array of more swiftly appreciating assets, she said.
Super Jumbo Loans
Celebrities, athletes, and other wealthy people who would take a shine to the cash-first, mortgage-second strategy that Ms. Peel described are in luck, because lenders seem to be more readily approving so-called “super jumbo” loans, which can range between $10 million and $20 million in the most extreme cases. (A majority of the that lenders are springing for are located in the top real estate markets of California, Florida and New York, The Wall Street Journal reported last year.)
The Mortgage Bankers Association reported in early April that overall mortgage credit availability increased in March to its highest level in four months “primarily due to a spike in jumbo mortgage offerings.”
Driving the current activity is the recent dip in mortgage interest rates, which led to a flurry of refinances from borrowers with larger loans taken in early 2019; the average refinance loan size increased to $438,900, a new survey record, the association . Overall mortgage applications surged 18.6% in just one week at the end of March, on the heels of the interest rate decline, according to the association.
"We had expected factors such as the ongoing strong job market and favorable demographics to help lift purchase activity this year, and the further decline in rates is providing another tailwind. Purchase applications were almost 10% higher than a year ago,” Joel Kan, the association’s associate vice president of economic and industry forecasting, said in a statement.
Richard Barenblatt, an independent mortgage broker with New York City-based Guardhill Financial Corp., said big banks are courting high-net-worth individuals for such jumbo loans because, for one thing, it’s a first step toward building valuable, long-term relationships with borrowers.
“What they’ll often say is, here’s our rate, but if you move $1 million, for example, to us (for a mortgage) we can take a quarter of a point off the (interest) rate, or half a point off the rate,” Mr. Barenblatt said.
He added that he recently spoke with a client who is the CEO of an international advertising agency. The client has millions of dollars in assets but is applying for 85% financing for an apartment in New York City that is priced a little under $3 million. That client is exactly the type of person a bank might make such a deal with.
And if other high-net-worth borrowers play their cards right and smartly manage their outside investments, this tendency of banks can work out to their advantage, too, Mr. Barenblatt said.
Banks “are willing to give away the interest rates, so to speak, take a loss even on the interest rate ... with the possibility that they can establish a relationship with (the borrower) and provide other services, whether it’s credit cards or business loans or arranging whatever it may be.”