It was breaking news earlier this year when Meghan Markle and Prince Harry finally found a place to land in Montecito, California: Their new nine-bedroom home came with a $14.65 million price tag, but perhaps more interesting, a $9 million mortgage. But they’re not alone: Celebs like Chrissy Teigen and Beyoncé have similar financial setups with Teigen recently confirming on Twitter that her and husband John Legend make payments on their California home while Beyoncé and Jay Z took out a $52.8 million mortgage on their $88 million Bel Air mansion vs. shelling out cash to pay for the whole thing in full.
But this leaves non-celebs like us scratching our head: Why would you take out a mortgage if you can afford to buy your home outright? We asked a couple of financial experts to explain.
There’s a reason Beyoncé, Meghan Markle and Chrissy Teigen all make payments on their sprawling properties. If you can finance a house with a mortgage, you should, says Lauren Anastasio, certified financial planner at SoFi, a personal finance company. “While the wealthy may have the wherewithal to buy real estate outright, the ability to finance a home gives you leverage. In other words, they have the ability to borrow money and invest the cash they held onto with the expectation that the investment will earn more than the cost of the loan,” she says.
An example: Let’s say that [insert celebrity couple here] buys a home for $8 million. They pay cash for half of it, then take out a $4 million-dollar mortgage—aka they could be borrowing $4 million at an ideal time with a low interest rate (for instance, currently, interest rates are 3 percent). From there, they have a certain amount of time to pay it back (most commonly for mortgages, the time span is 30 years). So, in the meantime, that $4 million cash they held onto can be invested elsewhere in things like additional real estate properties, private ventures, the stock market, etc. “It’s more than reasonable to expect that investing in the stock market could return on average 7 percent,” Anastasio explains. “If it only costs 3 percent to borrow the money, your fave celeb couple is able to net 4 percent per year on that $4 million.”
Back to why this is better than paying in cash: Leveraged investing is a good idea because it frees up that money you didn’t spend on your house for other purposes. And that’s not all: There are potential tax benefits associated with mortgage loans. In the right circumstances, a wealthy homeowner can deduct the interest paid on their mortgage in a given year up to a loan amount of $750,000, which further increases the value of the inexpensive mortgage debt, Anastasio adds.
Per Anastasio, taking out a mortgage on a property that a celeb can afford to buy in-full is one of the ways that the rich are able to get richer. But why can’t you apply that same way of thinking to your own home buying strategy? Caroline McCarthy, vice president at Own Up, says you need to weigh a trio of factors first.
First, you have to look at the rate of return if you were to invest your money elsewhere. “If your mortgage is $250,000 and you secure a 3 percent mortgage and you can now invest that $250,000 cash (OK, or a portion of it) you held onto in a place—say, a mutual fund—that earns you 4 percent a year, you should take out the mortgage. You’ll pick up a 1 percent return—tax benefits aside—instead of no mortgage and no investment vehicles.” Of course, this presumes you have that extra $250,000 already in your pocket, ready to be invested. (Most people don’t have bloated bank accounts like celebs and that’s OK—mortgages are a smart home buying strategy regardless.)
Second, consider the tax benefits. Since the interest you pay to buy a house is tax deductible up to a purchase price of $750,000, the savings effectively make it as if you are paying an even lower rate because of the tax deduction. (More money back in your pocket.) That said, it’s important to evaluate whether taking the standard deduction—currently at $12,400—will exceed your combined itemized deductions, which include mortgage interest, to determine which will be more beneficial for you, McCarthy explains.
Finally, you should look at the house’s potential to appreciate in value. “If a property goes up in value—which it likely will over time, unless the land is unusable—even if you only make a modest down payment, you don’t have to share that appreciation with your lender,” says McCarthy. She adds that too much debt can be dangerous, but for those who are diligent about making their payments and setting up a budget wisely, this could allow you to cash in on all of the home’s appreciation as part of your overall return.
Taking advantage of real estate financing is a strategy that can be used whether you’re buying a $300,000 home or a $3 million home. In fact, any homeowner has the ability to borrow money at a low rate with their property as collateral, Anastasio explains. The celeb-like benefits come when you weigh the opportunity cost. “Many homeowners like the idea of paying extra on their mortgage over time, whether it’s rounding up their payment each month or making an extra payment every year,” she says. “You have to ask yourself: ‘Could I wind up with much more in the long run if I took that extra money and invested it instead?’”
One more celeb-driven example: Let’s say Beyoncé takes out a $20 million loan with that 3 percent rate, but keeps her own $20 million in the bank and invests that money elsewhere while paying off a low-interest loan. It’s about the opportunity cost. The odds are in her favor that she’ll make more long-term.
McCarthy does have one final word of caution: You need to look at your overall liquidity (cash assets) and future plans, too, before deciding the best way to proceed. Home buyers should always take other financial obligations—credit card debt, personal loans and student loans—into account as they decide their mortgage approach. “For borrowers who are deciding between paying their mortgage down faster vs. alternative use of those funds, it’s important to look at other potentially higher rate debt obligations that should be retired first. From a lender perspective, the reason a mortgage rate is below these other rates is because there is collateral tied to it. From a borrower perspective, it’s often beneficial to take out your maximum loan size (if you can afford the monthly payments) to reduce the need for other types of personal loans,” she explains.