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Buying a House is like trading CFDs or any Leveraged Product

Spreadbets are derivatives and are leveraged, but debt is just one way of getting leverage. Debt and leverage are not strictly the same thing. Most homeowners who buy a house for investment purposes using a mortgage are leveraging using debt. Spreadbets are naturally leveraged speculations but not through debt.

Buying a house right now is tantamount depositing your entire life savings on a percentage of a share that's massively overpriced and due a pullback to value. From a trader's perspective both the fundamental and technical indicators say SELL SELL SELL, but most people aren't traders, hence why they are so desperate to BUY BUY BUY.

A mortgage is very similar to a contract for difference or a spread bet. Some people scoff at my spread bet dealings but don't think twice about committing 10 times the money I muck about with on spread betting to a mortgage with the potential to lose a lot more!

What's most interesting is that a lot of novice buy to let (BTL) investors have no idea of money management, i.e. how you manage your positions: when to put money in; when to exit or how to draw out profits and handle the risks to capital. I'm not an expert but it takes you about 5mins spread betting to realize that you can quite quickly come unstuck if things go against you, and adding more fuel to the fire doesn't help!

For all these recent property millionaires who have leveraged all the way up I reckon a drop of 3% will send them squealing for the door. I'll try to draw up an illustration as to why...

With CFDs you put down 5 or 10% of the actual share price and get full exposure to the rises and falls of that share or commodity.

For example, a share trades at 100p, you put down 10p, if the share goes up to 110p, your 10p goes up 10p to 20p and you have effectively doubled your money.

However, if the share goes down 10p to 90p, your 10p CFD goes down 10p and you are left with nothing.

Many first time buyers might put down 10k on a 100k flat and borrow the rest. With that 10k they gain full exposure to the rises and falls in the value of that house. House prices go up 50%. That 10k is now 50k - 5 times their original investment. Their house doubles in value, their stake in that house is 100k: ten times their deposit.

The housing sector has done incredibly well over the last 10 years. People who bought a house with a mortgage will have enjoyed the above leveraged exposure and will thus have beaten the market, without even realizing they have effectively been trading a leveraged product.

No wonder they remain so bullish about housing.

However, the downside. Let's say the sector doesn't do so well. That 100k house goes down 10%, the first time buyer loses his entire stake (plus expenses) and is saddled with a 90k debt. The house goes down 20%, the FTB has lost his stake, his expenses, is sitting on another 10k of debt on top of the original 90 on a depreciating asset he will find hard to sell.

The house goes down 30% and the losses of this debt trap become frightening.

With many warrants you can never lose more than your original stake. With CFDs you can put stops. But with a house you can't just click on a button to stop your losses. You actually have to sell it. And if you can't your losses get bigger and bigger and bigger. You are getting leveraged exposure to the downside.

And you can't go short on a house to hedge.

On the upside though, at least when you're trading this type of leveraged product, you have a house to show for your losses.

Of course there are differences like -:

Do you get an income from CFDs? With a house you get an income, in the form of being able to live in it.
Another thing: once you have bought the CFD, does it cost anything to keep it going (i.e. service the leverage) from month to month? Getting a mortgage obviously has the cost that you have to service the debt.
Another important difference - you don't tend to get margin calls on a house, so you can ride out the dips. Holders of CFDs get shaken out in bad patches.

But my essential point, that by buying a house with a mortgage you are effectively buying a leveraged product, remains.

The larger the mortgage, the greater the leverage.

In buying houses, many people have over the last ten years been UNCONSCIOUSLY trading leveraged products - usually with great success, because the sector has done so well.

In many cases, it is the leverage on the market rather than the market itself that has made people so much money.

But when then sector does badly, then what?

This is people think property has been so good, because while the absolute returns have been good, the *geared* returns have been massive. People are fine about gearing their property (probably simply because everyone else is doing it), but (somewhat anomalously) they would be very skeptical about CFDs or other kinds of geared investments.