Saturday, April 30, 2011

Having a Mortgage is Throwing Money Away

Let’s take two people, Person A and Person B:
Both are 22 years old; they just graduated from college and make the same salary.
They each have a “housing budget” of $1,000 per month.
(This housing budget, for the sake of simplicity, will never increase.)
They will make 5% on any money they invest.

Both of them eventually want to own a $200,000 home.

Person A wants to buy a home as soon as possible. He rents an apartment for $500 a month and invests the other $500 to save for a $40,000 down payment (20% of that $200,000 home.) Earning 5% on his investments, it takes just under 6 years to do this. At the age of 28, Person A takes out a 30-year 4.5% mortgage for the other $160,000, and now allocates his entire $1,000 housing budget toward his mortgage payment.

Person B, on the other hand, is going to rent for as long as possible and buy the house with cash. He too rents an apartment for $500 a month and invests the other $500 until he builds up a balance of $200,000. Earning 5%, it takes just under 20 years to do this. At the age of 42, Person B buys the house with cash.

Person A will own his home free and clear, as promised, at the age of 58.
He will pay roughly $150,000 in interest and $75,000 in taxes over the course of 30 years.
Let me repeat that: He will pay about $225,000 in interest and taxes – on a $200,000 home.

Person B will also own his home free and clear, but at the age of 42.
He can spend the next 20 years doing it again.
He paid $0 in interest to the bank during that time.
Still think it’s fair to assert that renting is “throwing money away?”
Bankers and real estate brokers sure would like you to.
(Who, exactly, do you think perpetuated that belief to begin with?)

Now, here’s the stipulation: Person B invested the other half of his budget, and he did it each and every month. He didn’t go buy a new TV or tons of shoes. He definitely didn’t start renting an apartment that cost $1,000 per month.  He was disciplined.

Some of us aren’t that disciplined, and wouldn’t save the other half of our budget. Some would end up spending the other $500, and when they retire, they’d have nothing to show for 40+ years of work.
Here’s the secret: that is who mortgages are for.

So: which type of person are you?

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