What were you doing in 10th Grade? The last thing on my mind was purchasing a home and my retirement. I was much more interested in rebellion, snowmobiling, boating, did I mention rebellion. Amidst all of the curriculum approved by the State of Wisconsin, the “What is the Magna Carta? What was Sherman’s March? What is the boiling point of alcohol? was a lesson in Math on Cumulative Interest. Looking back, I wish there was a gold star next to the lesson’s that can reshape generations, your grandkid’s, kids lives. Maybe even have a special area in the High School referred to as the “HIGHLY APPLICABLE WING”. We can’t look backwards though can we…as I was moving from one Honor’s Study Hall to the next sticking pencils in the ceiling praying for it to be over, I missed it. The lesson of all lessons. Cumulative/Compound Interest.
Here I am 14 years later and actually had to Google what year that lesson was covered because it was SO long ago. Now nearly a decade into the real estate business and working to blend a great life while creating a great legacy, I stumbled across the lesson again. Where? Well, believe it or not, in church. My wife invited me to something called Financial Peace University by Dave Ramsey and WOW what an eye opener especially for my industry. After the 8th lesson at FPU, I was reviewing some real estate statistics and what I found put me back in my chair. The following is the scenario I cooked up:
A 200k Loan at 3.4% is truly after 30 years going to cost you: $319,306.49
Now let’s say interest rates will rise to 4.4% by years end the difference in monthly payment is: $114.56 (Savings if you BUY NOW)
Now let’s say you buy the home today instead of years end, even assuming no appreciation of the home, you save that $114.56, but instead of spending that on Twizzlers, Movies and Over-sized Popcorn, you invest it.
You open an IRA and invest in Growth Stock Mutual Funds earning a steady 11%, you start out with a $1,000 deposit and then deposit the $114.56 into the IRA monthly….after 30 years you have an IRA worth: $347,993.88
So let me sum this up for you…the money you save if you bought today vs. waiting for interest rates to rise to 4.4% could essentially earn you a rebate in the entire Principal and Interest on your home after 30 years. This is a game changer…had a REALTOR paired with a Financial Planner explained this to me at a basic enough level that I could understand it at 20 years old I would have learned this lesson in APY instead of the lesson I learned in APR from Credit Card Companies. I bought my first home when I was 20…assuming the same scenario, my IRA would have $38,000 in it, I would be 18 years from owning it free & clear and having 100% of my P & I coming back to me through compound interest.
Am I the only one that didn’t look at this? I feel like the last one to the party on this one. What do you think? Are you floored or bored? Shoot some comments my way!
In My Head 
I like this idea a lot. It is similar in concept to my days with UFirst which sold a product that helped you pay off your mortgage early. Some thoughts that come to mind: What is the Tax liability when the monies are liquidated? That would reduce the net amount. Secondly, my wife works in the Mutual Fund Business, finding or “chasing” a fund that would consistently pay the types of returns necessary to make the equation work, is not that easy of a task. If it where, everyone would be rich. A fund may have good returns one year and bad the next, so an association with a fund manager would seem critical to the success of the outcome, and of course would result in a fee. Another thought is that this principle does not have to be addressed out over a 30 year period to be successful. Considering the average ownership is between seven and ten years, even the investment during this period of time would result in a substantial return and offsetting to the loss of equity to interest payments. Even applying these “gained” funds and applying them to paying down the principle each month would give you substantial savings and additional equity as the mortgage is a “living” instrument that is reset each month. In other words, the interest on you mortgage principle is charged on the balance remaining. The lower that balance is every month, the lower you total outlay of interest payments will be over the life of the loan. This process will also generate significant savings and or equity when selling the property. If you consider a Mortgage of $100,000 @ 4% for a term of 30 years, total interest paid over the life of the loan with NO pre-payment would be $71,869.51. But, if you paid just $100 per month more towards the principle, your total interest paid over the life of the loan (with pre-payment) would be reduced to $49,405.00 Your Savings Total interest saved: $22,464.51 and 8 years and 5 months shorter loan. This process can be accelerated by applying the extra saving to the principle. In addition, if one would pay off high-interest credit, like cards and revolving, and applied those payments to the principle, the property could potentially be paid off in as little as 5-10 years multiplying the interest savings and equity.
In conclusion, both ideas, are really great, proactive solutions that the “rich” understand as a tool to create more wealth. The pay-down of principle works best when interest rates are higher. Thus the first idea seems more logical under present circumstances. In other words, it is better to invest the money to get a 6-11% return than to pay down a relatively low interest rate of 3.5- 6 %. But unfortunately both require a specific amount of discipline and sacrifice that most of the general public are not willing to consider.