Overview
This is the third in a series of articles on whether you should pay off your home loan early. In the first article, I covered the importance of considering the opportunity cost, tax consequences, and whether you have other debts to consider paying off first. In the second article, I provided examples of paying cash for your home in only about 10 years with no loan. In this article, I will continue the previous article buy providing an alternative of keeping your funds invested longer before taking out cash to buy your home. A future article will continue this series providing various scenarios for paying extra on your existing mortgage to accelerate payoff of your mortgage debt.

Recap of using a \$100,000 mortgage in these articles
For simplicity, I use a \$100,000 mortgage in all of these articles. That way you can simply multiply all numbers in the articles by the multiplier that matches your home mortgage. If you have a \$200,000 mortgage, then use a multiple of 2 (your \$200,000 mortgage divided by \$100,000 mortgage of my articles gives a multiple of 2). If you have a \$500,000 mortgage, then the multiple would be 5, etc. Just divide your mortgage by \$100,000 to get the multiple to use.

Recall in the previous article that I showed how you could pay cash for your home after only about 10 years of investing. The benefit of doing so is that you never need to have a mortgage and your reward for waiting 10 years to buy the home is a home free of debt. From that point forward, you can continue investing to create wealth for retirement or other plans you may have.

However, using you full investment funds to pay cash for a home would lose the momentum of compounding interest that kicks in strongly at about that same time. In the previous article, I showed how investing instead of making a mortgage payment for 30 years would provide a balance around \$500,000 to well over \$1,000,000 that would be lost if all funds were withdrawn to buy the \$100,000 house. Therefore, another alternative would be to wait until your investments reached a \$200,000 balance before removing \$100,000 to pay cash for the home. This way the other \$100,000 balance would be large enough to continue compounding into a significant sum after 30 years. In fact, waiting for your investments to grow from \$100,000 to \$200,000 will not take near as long as the first \$100,000 did. In the last article, I showed the time it took to reach \$100,000 for the different investing scenarios. Here I will repeat those tables and add another line showing how long it will take to reach \$200,000 under those same investing scenarios.

When would you have \$200,000 to buy the house with \$100,000 cash and keep \$100,000 to compound?
If \$536.82 per month were invested instead of used to pay a 5% mortgage, you would have \$100,000 and \$200,000 by:

Balance 4% 6% 8% 10%
\$100k 13 years 11 years 11 years 10 years
\$200k 21 years 18 years 16 years 15 years

If \$599.55 per month were invested instead of used to pay a 6% mortgage, you would have \$100,000 and \$200,000 by:

Balance 4% 6% 8% 10%
\$100k 12 years 11 years 10 years 9 years
\$200k 19 years 17 years 15 years 14 years

If \$665.30 per month were invested instead of used to pay a 7% mortgage, you would have \$100,000 and \$200,000 by:

Balance 4% 6% 8% 10%
\$100k 11 years 10 years 9 years 9 years
\$200k 18 years 16 years 14 years 13 years

If \$733.76 per month were invested instead of used to pay a 8% mortgage, you would have \$100,000 and \$200,000 by:

Balance 4% 6% 8% 10%
\$100k 10 years 9 years 9 years 8 years
\$200k 17 years 15 years 13 years 12 years

What would your 30 year investment balance be under these scenarios?
Here I will show three different 30 year ending balances for each monthly investment scenario. The \$0 line assumes you never remove funds from the account to show what the ending balance would have been. The \$100k line assumes \$100,000 is removed immediately when the funds reach that amount and then the monthly investment is continued through the 30 years. The \$200k line assumes \$100,000 is removed only when the account balance reaches \$200,000 and then the remaining \$100,000 is compounded along with the addition of continued monthly investments.

Investing \$536.82 per month (a 5% mortgage payment) for 30 years would provide the following ending balances:

\$ Removed 4% 6% 8% 10%
\$0 372,580 539,244 800,055 1,213,475
-\$100k 168,743 227,454 313,878 436,837
-\$200k 224,977 328,990 486,482 733,543

If \$599.55 per month (a 6% mortgage payment) for 30 years would provide the following ending balances:

\$ Removed 4% 6% 8% 10%
\$0 416,117 602,257 893,545 1,355,276
-\$100k 203,269 274,522 377,408 525,326
-\$200k 259,403 376,798 556,195 833,816

If \$665.30 per month (a 7% mortgage payment) for 30 years would provide the following ending balances:

\$ Removed 4% 6% 8% 10%
\$0 461,751 668,304 991,536 1,503,903
-\$100k 241,701 325,522 447,221 624,312
-\$200k 296,467 427,742 628,606 942,004

If \$733.76 per month (a 8% mortgage payment) for 30 years would provide the following ending balances:

\$ Removed 4% 6% 8% 10%
\$0 509,266 737,073 1,093,566 1,658,656
-\$100k 281,769 380,338 523,336 734,159
-\$200k 336,099 482,944 705,701 1,053,182

Opportunity cost of both options
Opportunity cost is the difference between what would have been earned by investing without withdrawing funds to buy a house and either the \$100k balance or \$200k balance option ending balances shown above. For example, in the \$599.55 monthly investment table above you see at 8% you would have had an account balance of \$893,545. However, if you chose to withdraw \$100,000 to buy the house immediately when \$100,000 was in the account, your 30 year ending balance would only be \$377,408. The difference of \$516,137 (\$893,545 – \$377,408) is the lost opportunity, funds you lost by withdrawing the \$100,000 immediately. You can think of this as the \$100,000 house costing you \$616,137 over 30 years since you paid \$100,000 and lost another \$516,137 in opportunity cost.

If you chose to wait until the account had \$200,000 to withdraw \$100,000 for purchase of the house, then you 30 year ending balance would be \$556,195. The difference of \$337,350 (\$893,545 – \$556,195) is a much less opportunity loss. However, the house still cost you \$437,350 or your \$100,000 paid and the \$337,350 opportunity cost.

Both of these total costs of your house are much less than taking out a 30 year mortgage with the associated monthly payment where you end up paying several times your home price in interest. You also lose out on the monthly investment and associated compounded balance had you invested the monthly mortgage payment over 30 years instead, as seen in the examples above. If you think about it, purchasing a \$100,000 home with a mortgage could cost you well over \$1,000,000 and even closer to \$2,000,000 with the combined opportunity loss from no investment and the loss from paid interest over 30 years to the bank. Most sophisticated accredited investors understand this fact and wait for this reason to pay cash for their home. They would much rather pur their money to work making more money than give it to a bank in interest payments.

Summary
You can see how having patience to put off purchases and being a debt-free investor can help you create large wealth over your lifetime. I plan to continue this series on paying down mortgages so stay tuned.

Copyright 2009 Ole Cram, President of Marcobe Investments, Inc.

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