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Imprudent Use of Leverage: A Contrarian Opinion

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Brian Brady

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Contrarians zig while other investors zag.  They hold to the belief that most people receive news too late and act irrationally.  Warren Buffett illustrates the contrarian approach best:

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.

Let’s talk about how mortgages can be applied to the Buffett School of Contrarian Economic Theory;  you should probably be maxed out to the hilt on your properties.  “Mortgage Planning” was a sales technique we debt peddlers used, during the boom.  We dressed up serial refinances, to the maximum permitted loan-to-value, and called it “home equity harvesting“.  The theory suggested was to make money from arbitrage opportunities by borrowing against your (appreciated) principal residence at x% and investing that money at (1.25) x%.

Financial advisers like Ric Edelman championed this cause by lending credibility to the theory through best-selling books.   Seminars were held by guys in thousand dollar suits, displaying multi-color charts, showing how the incremental benefit of that arbitrage, compounded over time, could result in a king’s ransom for the intelligent “investor”.  They forgot to discuss the key ingredient to the use of leverage…

Can you service all of that debt?

The real estate market tanked, the stock market dove, and junk bonds defaulted, leaving those “investors” with depreciated assets, bought with money they couldn’t afford to repay.  A sad tale of woe, indeed.

Still, I think you should “bet the ranch” today.  Here’s why:

There’s a catch, though.  You must be able to afford all of that debt. If you borrow an extra $100,000, to buy $300,000 worth of property, be certain that the income being produced from that $300,000 services ALL of the debt incurred, including the marginal monthly increase from the withdrawn home equity.

The whole world is talking about the great de-leveraging in which governments, businesses, and consumers are engaged.  They’re all zigging so I say you should zag.  If they’re saving and receding,  you start borrowing and buying.

A contrarian opinion.  Caveat Emptor.