Real estate has long been seen as the rich man’s game, with incredibly high economic barriers to entry that have historically excluded the vast majority of people from participating; indeed, for much of history, being a land-and property-owner was a signal of one’s wealth.

Since its inception in Britain, the mortgage, or death pledge, has been a powerful tool for the acquisition of real estate, providing increased opportunities for the common man to advance their station and holdings in life.

Throughout this time, the function of the mortgage has remained relatively unchanged: to provide an individual increased up-front buying power through debt-leverage for the purposes of transacting large purchases of real estate which would otherwise be out of reach. 

The purchased property is typically used to collateralize the initial loan, allowing for some of the lowest interest rates available due to the increased security for lenders provided by the underlying real estate asset, which may be foreclosed upon should the borrower be unable to meet the obligations of their debt.

Increased buying power

Despite the intimidating connotations, mortgages have historically been essential in the growth of the property-owning class by increasing buying power far in excess of what someone may be expected to save on their own through debt-leverage.

Due to the large sums of capital required to buy a property, the process is out of reach for most people without external support from lenders. By means of the mortgage, an individual can transact a purchase of property with a bare fraction of the required up-front capital with the rest of the purchase transacted in highly secured debt.

For their part, lenders are provided assurance of recompense on their loan by the underlying assets, in case of default on the mortgage debt, the underlying assets ensure the security of the loan repayment.

This means that, typically, mortgage debt is amongst the cheapest forms of borrowing. Today, in Canada, mortgage rates are at historic lows, allowing borrowers to take out 5-year fixed interest rate mortgages with rates as low as 2.14%.

Locking in a price

In a world where real estate values in desirable locations (such as Toronto) have been consistently rising, a mortgage is also an excellent way of locking-in the price of a property, effectively acting as a forced savings mechanism.

Through a mortgage, an individual is able to pay the full, up-front cost of acquiring real estate at its current valuation, then paying off the debt over an extended period, whilst simultaneously reaping the rewards of rising property values. In a hot market, such as Toronto, this will typically mean that one’s equity value in their real estate holdings will outpace interest payments, leading to a net asset increase.

However, there is a flip side to consider when locking in a mortgage, if the real estate was overvalued at the time of purchase and subsequently depreciates below the value of your mortgage, individuals may find themselves trapped in a situation where the underlying asset they originally took on mortgage debt to purchase is no longer of sufficient value to cover the outstanding principal amount, resulting in a net loss and credit crunch for the borrower.

Interesting considerations

No evaluation of a mortgage can be properly conducted within a vacuum.

Local property market trends play a large role in evaluating whether or not a mortgage makes sense to acquire. However, perhaps an equally significant consideration has to be the financial climate in which the borrower resides.

Mortgage debt is essentially just another form of debt, after all. When evaluating whether or not it is a smart decision to take on mortgage debt, the opportunity costs of other avenues (even other mortgage options) are worth considering.

To keep it simple, the goal of a borrower will always be to minimize the total interest they have to pay on their principal mortgage loan.

There are two kinds of mortgages to consider: fixed-rate, and adjustable-rate mortgages (ARMs).

Typically, a fixed-rate mortgage will carry a higher interest rate than an adjustable-rate mortgage, however, they offer the benefit of a predictable and stable repayment calculation. Conversely, adjustable-rate mortgages will generally be offered at lower interest rates, but come with the uncertainty that rates may rise.

In the most dramatic of circumstances, this means that holders of adjustable-rate mortgages may face scenarios in which their monthly payments adjust to become unsustainable due to unanticipated rate increases, resulting in a default on the mortgage and subsequent credit issues.

Let’s face it, a mortgage is a LOT of debt

Of course, nothing originally referred to as a death pledge will be all sunshine, rainbows, and increased opportunity, and mortgages certainly come with their own attendant shortcomings, namely: debt.

A LOT of debt.

For most individuals, especially aspiring first-time homeowners, mortgage debt will be the largest financial obligation of their lives.

Right now in Canada, consumers have $2.3 trillion in outstanding mortgage debt obligations, equaling $1.77 in debt for every $1.00 Canadian consumers have available to spend.

This comes with serious consequences.

While it is true that on their paper balance sheets the majority of mortgage holders will be in a positive position, that doesn’t account for the fact that the vast majority of their net worth will be tied up in the illiquid asset of their property.

In order to successfully meet their mortgage obligations, the average Canadian with a mortgage will need to structure their finances around servicing this large debt, to the detriment of their greater financial freedom.

An easy way to break down this consideration is to think of it as trading your short-term financial freedom for a strengthened financial position many years from now.

Just another tool

Ultimately a mortgage is just another financial instrument in one’s toolkit for navigating modern life, and is only as beneficial, or detrimental, to one’s finances as their usage allows it to be.

Used most wisely, a mortgage enables aspirations of homeownership years sooner than would otherwise be possible.

With its’ worst misapplication, a mortgage can have far-reaching financial consequences.

For those who dream of homeownership and are comfortable with the long term financial commitment it entails, a mortgage remains a powerfully enticing option.

For those who place a higher value on their financial flexibility and freedom, other options are being developed all the time.

Disclaimer: This blog is not intended to provide advice or counsel with regard to mortgage decisions, but rather to provide a brief overview of the pros and cons of a mortgage. For specific advice, please consult a mortgage broker in your area.