This blog is adapted material from the video “Who Owns This House” on WhereLifeMeetsWealth.com.
I’m of the opinion that everyone should have their home paid off—as fast as possible. Choosing the right loan to accomplish that can be confusing, though. That’s because many people ultimately make decisions based on what they believe to be true, and not what necessarily is true. Let’s work to separate fact from fiction so you can pay off your home in the fastest, safest manner possible.
Before we begin, let’s take a little quiz.
- A large down payment will save you more money on your mortgage over time than a small down payment. True or false?
- A 15-year mortgage will save more money over time than a 20-year mortgage? True or false?
- Making extra principal payments saves you money. True or false?
- The interest rate is the main factor in determining the cost of a mortgage. True or false?
- You’re more secure having your home paid off than financed 100%. True or false?
If you answered true to any of these questions, you’re going to want to continue reading.
Many mortgage decisions are commonly made by looking at payment amount and interest rate. While these factors are important, there are several other factors that also must be considered.
To help understand how these factors might ultimately impact you, we’ll look at some fictional couples. Each couple has the same goal—get their home paid off. They each firmly believe their method is the best.
The first couple is the “Free-n-Clears.” They have paid off their mortgage, so they do not have to make anymore monthly mortgage payments.
The second couple is the “Owe-it-Alls,” who could have paid cash for their home like the “Free-n-Clears,” but decided to keep their money, $300,000 worth, and invest it in a safe account so they could access it in case they ever needed to. Although they owe it all on their mortgage, they have no other debt.
The third couple is the “Pay-Extras.” They make extra principal payments each month in hopes of paying their mortgage off as soon as possible.
So, which of these couples do you think is in the best position? Let’s explore several mortgage factors to find out how they impact each couple.
One area people often forget to consider when financing is inflation. If you have a fixed payment today of $2,000 per month, what will that same $2,000 buy in 10, 20, or 30 years? Assuming an inflation rate of 3%, $2,000 will only buy $823.97 of goods in 30 years. Let’s apply what this means to you and your mortgage.
Making a fixed mortgage payment today feels like $2,000, but in 30 years it will feel like you’re paying $823. So, the mortgage payments you make in the early years of your mortgage feel more painful because they are your most valuable dollars.
So, let’s check in on the couples. The “Free-n-Clears” gave their most valuable dollars to the bank up front; the “Pay-Extras” voluntarily give the bank their best dollars, on top of their required mortgage payment every chance they get; and the “Owe-it-Alls” have a monthly mortgage payment that allows them to give the bank payments that are worth less and less each month, while keeping their money invested to potentially off-set the impact of inflation.
Key concept? Your home actually costs more the faster you pay it off because you are doing so with your most valuable dollars.
Most people make a large down payment to reduce their monthly mortgage payment and save interest, but does their down payment earn them any interest? No. This loss is called opportunity cost.
Opportunity cost is when you lose a dollar you don’t have to lose, you not only lose that dollar but you also lose what that dollar could have earned you, had you been able to keep it.
What would the “Free-n-Clears” down payment be worth, had they been able to keep it and invest it? Let’s see what the math says to take a deeper look.
Assuming each of the couples bought a $300,000 home, the “Free-n-Clears” made the biggest down payment possible—the entire $300,000.
With a down payment of $60,000, the “Pay-Extras” did not have enough up front to purchase the home outright, so they accelerate the principal payments by paying extra each month.
Finally, the “Owe-it-Alls” put the least amount down, zero dollars, and financed as long as possible. Assuming an investment rate of 8%, the $300,000 the “Owe-it-Alls” invested would grow to be $3,280,719 in 30 years. If they could borrow the $300,000 at a lower rate, they will keep the difference.
The $300,000 payment the “Free-n-Clears” made will earn no interest. So, if the “Free-n-Clears” cannot sell their home in 30 years for $3,280,719, they made a minor financial error.
Check back soon for Part 2 of “Who Owns Your House?”. We’ll discuss investment opportunities, appreciation, and the interest rate spread.
Chris Jacob is a Registered Representative with Saxony Securities, Inc.. Securities offered through Saxony Securities Inc. (SSI). Member FINRA, SIPC. Non-security products and services or tax services are not offered through SSI. Cadeau is not affiliated with SSI.