By: Stanley B. Greenfield, RHU
Just what is the value of money? I am not referring to the fact of what it will buy and things like that. I also know that money can’t buy a person happiness, but it can sure make you comfortable if you are miserable! What is the value of money? Money is worth what you can borrow it for. In other words if it will cost you 4% to borrow money, then having money in a savings account at 1% is not a good value for you. The same is true with this philosophy of getting yourself totally free of debt. Is it a good thing? Let’s examine a few items and see.
I am asked all the time about mortgages. “Should I have one?” “Should I get a 15 year instead of a 30-year mortgage?” Recently in the paper, I saw an ad by a very large bank showing how much better a 15-year mortgage was for the consumer. They started with a $125,000 mortgage and then compared the two. The 30-year mortgage had payments for 360 months, and the 15-year mortgage only had 190 payments. They used a 7.5% mortgage rate on both. The monthly payments on the 30-year mortgage were $874 versus $1,159 on the 15-year mortgage.
At the end of 15 years the 15-year mortgage was paid in full, but the 30-year mortgage had only paid off $30,717 of the $125,000 mortgage, leaving a balance of $94,283. The ad then went on to show how much interest both would end up paying. The total for the 15-year mortgage was $83,577. The 30-year total was $189,644, with a difference of $106,067. Wow!
I can picture people running down to the bank to refinance their mortgages to a 15-year term to save themselves over $100,000. The bank’s ad is very effective, and their- point is well made. Based on the numbers a person will save over $100,000 in interest payments. Am I saying that a 15-year mortgage is better than a 30-year mortgage? Well, let’s take a little deeper look at the numbers, before we all jump to any conclusions.
Before we do that I have a few statements to make. A 15-year mortgage will allow you to build equity faster in your home than a 30-year mortgage. Is that a good thing to do? That depends. If you want to be able to look at your personal net worth and brag to people that you have a lot of equity in your home, then it is a good thing. Other than that, what good is it? Can you use that equity for your kids’ educational fund? You could, but the minimum payoff is more than if you just funded their education out of your own pocket.
What about for a retirement fund? You can use your equity, but you must borrow it out at the current rate, whatever that will be. You also must be able to demonstrate that you have the ability to pay it off. If your home has no mortgage, you could get a new mortgage, but now the interest is NOT tax deductible. You heard me, right. If your “cost basis” in you home is “0,” then the mortgage is not deductible. Let’s move on now.
The difference in interest payments was $106,067. That is the “gross” difference. If you take a person in a 30% tax bracket it reduces the difference to $74,246.90. That’s still a big difference. If you remember, the payments were $1,159 for the 15-year and $874 for the 30-year mortgage. That’s a difference of $285 per month. Over 15 years, that’s a total of $51,300. What if we took that $285 difference each month for the first 15 years and put it in the bank at just 5% interest. What would you have after 15 years? You would have $77,497.20.
Now let’s take another look at the differences. We started with a difference in interest payments of $106,067. That was reduced to $74,246.90 at a 30% tax rate, since mortgage interest is still a deductible item. We then took the difference in payments of $285 per month and put that in the bank at just 5% and at the end of 15 years we have $77,497.20. If we subtract that from the interest, what you have left is $3,250.30. That makes the 30-year mortgage worth more. If we considered inflation, the 30-year mortgage would be worth even more.
So what am I saying here? Good question. What I am saying is that you need to examine the real value of money to make your decisions. If you are paying off your mortgage early just because someone told you that you should be “debt-free,” you need to re-examine that carefully. If you are paying off your mortgage so that you will have equity that is available to you, then I suggest you re-read this again and see the fallacy in that belief. Please remember that most homes in this country appreciate at a lower rate that the current inflation rate, so keeping your money tied up as equity is eroding its value. If you are paying off your mortgage early because you just don’t want to have any more mortgage payments, then that is fine and is a valid reason. Not every decision should be a dollar and cents decision, just as long as they make good sense!
Remember also that the 15-year mortgage requires an additional payment each month of $285.00. By the way, if you make just one additional payment per year on a 30-year mortgage, it cuts it down to a 24-year mortgage. If you took that additional $285.00 per month and didn’t leave it in the bank, but put it to work and earned 8%, at the end of 15 years you would have a total of $100,274.40. At 10%, you would have $119,529. Now you are seeing the value of money at work for you, not against you.
There you have it. Some food for thought. What’s best for you? Another good question! That depends on what YOU want based on an overall plan for YOU. The most important element in this whole equation is YOU, not what someone else is telling you is best for you. Become a more educated consumer and start taking more control of your finances and your financial future. As I say in my motto: GET THE POWER!