The truth about financing your home
By Jim Hallisey / Ozark Financial Services / Rogers, Arkansas
Here's an important question:
If what you believe to be about financing your home were not true, when would you want to know?
Your home is probably the largest or second largest personal investment you will make. How you decide to pay for it may cost you unnecessary lost opportunities of which you are not even aware.
True or False?
1. A large down payment will save you more money on your mortgage over time than a small down payment.
2. A 15-year mortgage will save more money over time than a 30-year mortgage.
3. Making extra principal payments saves you money.
4. The interest rate is the main factor in determining the cost of a mortgage.
5. You are more secure having your home paid off than financed 100%.
Conventional wisdom says, and I used to believe, that all the above statements were true. Then I began to do the math. What an eye-opener!
Why have a mortgage anyway?
1. You don’t have enough money to pay cash for your home.
2. Tax deduction (assuming you qualify and itemize the deductions on your tax return).
3. To pay off non-tax deductible car loans, credit cards, or college debt.
But what if you had sufficient liquid assets to pay cash? Why not own your home free and clear?
The third reason is the potentially profitable spread you might glean between the cost to borrow (your mortgage rate) and the rate you might safely earn in a separate account.
Wealth transfers will occur regardless of how you choose to pay for your home. If you finance your home you transfer interest to the lender for the privilege of using their money. If you pay cash for your home you lose the interest that cash could have earned if it were not tied up in the house.
Perhaps a hypothetical example will help:
If you live in a $200,000 home -- financed for at 5% for 30 years-- your payment would be approximately $1074 per month. Multiply 360 such payments and see that you pay a total of $386,640 in principal and interest for your $200,000 home.
If you qualify you could write off that $186,640 in interest and would be paying the lender back (due to inflation) with “cheaper” (worth less) dollars.
Meanwhile your $200,000 cash can be at work earning 5% per year for the same 30 years. Can you guess what it grows to in that timeframe? A whopping $893,549!
What if you don’t have an extra $200,000 available to be safely invested at 5%? Let’s compare a couple of other alternatives.
Have you ever said to yourself, “If we can just get our home paid off, then we can get serious about saving for the future?” Maybe you are even making extra principal payments or paying higher monthly payments to amortize your loan in 15 years rather than 30.
Consider this: A $200,000 mortgage at 5% interest would require monthly payments of $1,581.59 to pay it off in 15 years. If you paid it off and then safely invested the $1,581.59 per month at 5% for the next 15 years you would accumulate $422,741.
What if instead, you borrowed the same $200,000 at 5% over a 30-year term, thus reducing your payments to $1,073.64?
The difference between the 15-year and the 30-year payment is $507.94. That amount, safely invested at 5% per year over the 30-year term will produce a nest egg of the same $422,741 we generated in the example above.
And yet, it accumulates with less stress and more security, leaving you much more in control.
As you accumulate money in your side fund, there is nothing keeping you from paying your 30-year loan off earlier. In fact, in this very example, you would have enough in to pay off the remaining balance of your 30-year note at or before the end of the 15th year. Meanwhile you have the money available to use in case of an emergency or to take advantage of another safe opportunity that could earn you more than the 5% per year interest.
May I recommend that you go back and retake the quiz at the beginning of this article?
If your outlook has changed and you now consider these statements false, you may want to explore the “what ifs” of your own personal situation with a professional who can be objective (someone not in the mortgage business) and a software that compares one option against another. Your money matters, so if what you believe to be about financing your home no longer true, perhaps now if the time to do something about it.
This article provides general information and is not intended to provide legal or tax advice. Jim Hallisey (AR Ins. Lic. #98440) has spent the past 11 years with Ozark Financial Services helping people prepare to live out their hopes, dreams, and goals in retirement. He does so with an emphasis on producing safe, steady, secure growth creating a tax efficient income stream that his clients cannot outlive. Call Jim at 479-936-7890 with your questions or to schedule a visit. You may also learn more at his website www.jimhallisey.com.
