Free Money Matters.com

Where do you think you're going?

If you don't know where you're going, you'll end up somewhere else.

- Yogi Berra

How quickly should you pay off your home?

In my last post I ran a scenario of two people who had similar mortgages, $300,000, with the same mortgage rate, 7%, and with 30 years to pay it off - they also had an extra $500 bucks to burn every month - they could either use it help pay down their mortgage every month or use it to invest a tax deffered account - 401k - every month

Then I asked the question"who comes out ahead financially?"

it was the person that invested in a 401k - that person came out almost $300,000 ahead of the person who payed down their mortgage first THEN invested into a 401k

Well, what happens if we change some of the variables - what if the mortgage is only $100,000 and the extra cash to use to either pay down the mortgage or invest is reduced to $100 per month?

check out Len and Harry...

Well, looks similar to our previous result - the person who invests their money instead of prepaying their mortgage comes out ahead financially - in this case, Harry came out almost $50,000 ahead of Len

How quickly should you pay off your home?

What would happen if you had an extra $500 every month burning a hole in your pocket - would you:

1) use the money to help pay down your mortgage every month

or

2) invest the money in a 401k every month

Meet Ben and Jerry.  They live in the same neighborhood, have identical mortgages and identical mortgage rates. 

Ben wants to pay down his mortgage and puts the extra $500 bucks onto his mortgage every month on top of his normal payment.  Ben actually pays off his house in 18 years, 12 years sooner than Jerry. 

Now that his house is paid off, Ben now decides to invest the money he sunk into his mortgage every month and also the extra $500 bucks - which gives him $2,496 to invest into a 401k every month for the next 12 years.

Jerry doesn't make any extra mortgage payments with his extra cash.  But in 18 years, his extra $500 bucks in investments every month has turned into $270,817 (assuming he makes 9% interest on his investments).

..so who actually comes out ahead?

At the end of the 30 years, both guys own their own homes but Jerry comes out ahead financially almost $300,000 above Ben.  But in fact, Jerry is way ahead of Ben because this scenario doesn't even include the tax deduction on mortgage interest!

How quickly should you pay off your home?

A recent study (March 2007) titled "The Tradeoff between Mortgage Prepayments andTax-Deferred Retirement Savings" found that many households face a trade off between paying off their mortgage sooner or investing their money in a tax deferred investment (i.e. 401k). 

From the research conducted by Gene Amrominy (Federal Reserve Bank of Chicago), Jennifer Huangz (University of Texas at Austin) and Clemens Sialmx (University of Michigan) - it was shown that, under certain conditions, at least 38% of american households could benefit more financially from investing in a tax deferred investment account instead of prepaying their mortgage.

They found that a signficant proportion of households could benefit from a simple strategy that takes advantage of tax deductable mortgage interest payments and tax deferred retirement accounts.  If these households took advantage of this simple strategy, it could save american households 1.5 billion dollars per year.

Leaving Debt Behind

Probably the very best thing my earnings have given me is absense of worry. I have not forgotten what it feels like to worry whether you'll have enough to pay the bills. Not to have to think about that any more is the biggest luxury in the world.

- J.K. Rowling

How quickly should you pay off your home?

How secure is your job?  Are you self-employed, do you have confidence that your career will hold up over time?

This may be something to consider when thinking about prepaying your mortgage or sticking with investing for your retirement.

My job is not 100% secure and the industry that i work in is also notoriously unstable - for me having the peace of mind of having my house paid for - makes a lot of sense

Although...instead of paying off my house sooner, what if the money meant to pay off my house was invested and then used as an "emergency fund" to help my family out if i ever did lose my job and had a hard time finding work...   

The Rule of 72

Something that I had never heard of until recently was the rule of 72.  It is a simple technique to help you calculate an interest rate required to double your money in a given number of years - see below

1) calculate the number of years required to double your money at a certain intereste rate - for example -  How long will it take to double your money at 10% interest?  Divide 10 into 72 which equals 7.2 years - so it will take 7.2 years to double your money at 10% interest

2) calculate an interest rate required to double your money over a certain number of years - for example - What kind of interest rate will help double my money in 5 years? Divide 5 into 72 which equals 14.4 - so you need an interest rate of 14.4% to double your money in 5 years

How quickly should you pay off your home?

Recently, my wife and I have been debating what the better option is:

1.  Pay off the mortgage quicker

or

2.  Increase retirement savings contributions

what makes more financial sense?  I know that emotionally i would feel a lot better paying off the house but i think what might help me decide depends on a number of factors including:

size of mortgage, interest rate of mortgage, your age, how long to plan to live in the house, how much money do you have socked away for retirement, what kind of returns are you getting from your current investments (also what kind of investor are you?) and also what is the state of the economy (are we on shaky ground?)

Peace of Mind or Piece of Pie

Rather go to bed supperless than rise to debt.

- Ben Franklin

Sizing up Credit Card Debt

From CardWeb.com (a leading online publisher of information pertaining to all types of payment cards):

"An association representing U.S. bankers says it is a "myth" that Americans are "up to their eyeballs" in credit card debt, claiming that American households only carry about $200 billion in balances, despite government figures of more than $900 billion and industry data showing nearly $850 billion. Where is the missing $700 billion? The American Bankers Association referenced a nearly four year old Government Accountability Office study that showed the median credit card balance among families carrying a balance was $2,200 in 2004, meaning that 50% of families with credit card debt owe more than $2,200, while 50% owe less than $2,200. According to an online poll of more than 55,000 consumers, conducted earlier this year by CardTrak.com and released in May, the median amount of credit card debt carried by Americans is about $6,600 while the mean (or average) credit card debt load is nearly $9,900. Based on industry figures, and discounting balances paid-off in full each month and commercial credit card debt, Americans were revolving about $672 billion on all credit cards at the end of last year. Furthermore, the latest revolving credit figures released by the Federal Reserve show Americans owed $920 billion in September, which includes lines of credit attached to checking accounts. The "myth" is that Bankers are "up to their eyeballs" in current facts."

I wanna know who owes that money - is the lower class or middle class that owes the lion's share of this debt and how much does a lower class person owe on average - are they capable of paying their debt instead of just the minimum payments