From: Dale Gatherum-Goss
Hi!
The following arrived in my email box today from Noel Whittaker. I believed it was worth copying . . .
PAYING OFF YOUR HOUSE
My last newsletter on paying off your house quickly created much interest. I hope the following will help you understand the way it works.
We live in a world characterised by education and impatience. Today's investor knows the importance of investing for retirement, is aware of the wide range of products available, but also knows that paying off that huge non-deductible home loan should be a major priority. Consequently, they are dying to get started on the investment plan, but are torn between doing that and paying off their home loan.
Understanding numbers can lessen the confusion. Because of the way compound interest works, the large earnings come in the later years of any program. Invest $1000 a month at 10% for five years and you get $77,000 - increase the term to 15 years and it becomes $415,000. If you can make it 30 years the finishing sum leaps to $2.3 million.
It's the same with loans.
CASE STUDY You owe $150,000 at 6.5%. If you choose a 30 year term the monthly payments will be $948 and you will pay a total of $191 000 in interest. To cut the term back to 20 years needs just $170 a month more, in which case the interest will drop by $73,000 to $118,000. Now it's not too difficult to increase your payments by $170 a month, but of you wanted to cut the term from 30 years to 10 years you would need to pay $1703 a month - an increase of $755 a month. . In short, small extra payments can make a big difference when the term is long but the effect dwindles away as the term shortens.
But once the term is down to around 10 years extra payments don't help you much. In the example above there is just $54,000 still to be paid once the term is down to 10 years. Paying an impossibly high $13,000 a month would cut it back to one year but you would save only $49 000 interest.
Once you appreciate how small monthly amounts can be valuable in shortening a long-term loan, and that starting early makes a massive difference to an investment program, it is clear that it is possible to have your cake and eat it too. Just reduce your home loan to a reasonably short term and then borrow for investment.
CASE STUDY The Browns, aged 40, owe $100,000 on their home loan and are paying it back at $1135 a month which will have it paid off in 10 years. They decide to pay it off as their major priority and raise their payments by $822 a month to $1957 a month which will have it paid off in five years. This strategy saves $19,000 interest. Their friends, the Whites, are in a similar situation but are content to leave their loan at 10 years, At that rate there is only $36,000 interest left. Using a second mortgage against their home they use their $882 a month to borrow $200,000 to invest in blue chip share trusts. The interest is tax deductible which effectively halves the cost of it. If we assume the managed funds earn a 10% per annum (income and growth combined) their value will be $2.4 million when they retire at age 65.
At age 45, the Browns congratulate themselves on achieving their goal of being debt free but suddenly realise time is running out to save for retirement. Unfortunately they discover how compound interest works. Because their time frame is 20 years, they have to borrow $340,000 to end up with $2.4 million at age 65. This causes some soul searching - they can afford the interest only payments on a loan of $340,000 as there are no more home loan repayments to make, but $340,000 seems a huge amount to borrow for investment when all they have ever had is a modest home loan.
And what about the Whites? Five years later, when they are 50, they make their last home payment and find themselves with a spare $1135 a month. Investing this into managed funds that return 10% will give them an additional $470,000 at age 65. They cash this in, which nets them $405,000 after paying $65,000 capital gains tax. They use $200,000 to pay off their debt, and add the $205,000 to the other $2.4 million in their portfolio. The Browns are still trying to figure out to pay back their $340,000 loan.
Hi!
The following arrived in my email box today from Noel Whittaker. I believed it was worth copying . . .
PAYING OFF YOUR HOUSE
My last newsletter on paying off your house quickly created much interest. I hope the following will help you understand the way it works.
We live in a world characterised by education and impatience. Today's investor knows the importance of investing for retirement, is aware of the wide range of products available, but also knows that paying off that huge non-deductible home loan should be a major priority. Consequently, they are dying to get started on the investment plan, but are torn between doing that and paying off their home loan.
Understanding numbers can lessen the confusion. Because of the way compound interest works, the large earnings come in the later years of any program. Invest $1000 a month at 10% for five years and you get $77,000 - increase the term to 15 years and it becomes $415,000. If you can make it 30 years the finishing sum leaps to $2.3 million.
It's the same with loans.
CASE STUDY You owe $150,000 at 6.5%. If you choose a 30 year term the monthly payments will be $948 and you will pay a total of $191 000 in interest. To cut the term back to 20 years needs just $170 a month more, in which case the interest will drop by $73,000 to $118,000. Now it's not too difficult to increase your payments by $170 a month, but of you wanted to cut the term from 30 years to 10 years you would need to pay $1703 a month - an increase of $755 a month. . In short, small extra payments can make a big difference when the term is long but the effect dwindles away as the term shortens.
But once the term is down to around 10 years extra payments don't help you much. In the example above there is just $54,000 still to be paid once the term is down to 10 years. Paying an impossibly high $13,000 a month would cut it back to one year but you would save only $49 000 interest.
Once you appreciate how small monthly amounts can be valuable in shortening a long-term loan, and that starting early makes a massive difference to an investment program, it is clear that it is possible to have your cake and eat it too. Just reduce your home loan to a reasonably short term and then borrow for investment.
CASE STUDY The Browns, aged 40, owe $100,000 on their home loan and are paying it back at $1135 a month which will have it paid off in 10 years. They decide to pay it off as their major priority and raise their payments by $822 a month to $1957 a month which will have it paid off in five years. This strategy saves $19,000 interest. Their friends, the Whites, are in a similar situation but are content to leave their loan at 10 years, At that rate there is only $36,000 interest left. Using a second mortgage against their home they use their $882 a month to borrow $200,000 to invest in blue chip share trusts. The interest is tax deductible which effectively halves the cost of it. If we assume the managed funds earn a 10% per annum (income and growth combined) their value will be $2.4 million when they retire at age 65.
At age 45, the Browns congratulate themselves on achieving their goal of being debt free but suddenly realise time is running out to save for retirement. Unfortunately they discover how compound interest works. Because their time frame is 20 years, they have to borrow $340,000 to end up with $2.4 million at age 65. This causes some soul searching - they can afford the interest only payments on a loan of $340,000 as there are no more home loan repayments to make, but $340,000 seems a huge amount to borrow for investment when all they have ever had is a modest home loan.
And what about the Whites? Five years later, when they are 50, they make their last home payment and find themselves with a spare $1135 a month. Investing this into managed funds that return 10% will give them an additional $470,000 at age 65. They cash this in, which nets them $405,000 after paying $65,000 capital gains tax. They use $200,000 to pay off their debt, and add the $205,000 to the other $2.4 million in their portfolio. The Browns are still trying to figure out to pay back their $340,000 loan.
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