The following is an illustration adapted from the book, The New Rules of Money. It uses a $200,000 home purchase as an example, which we all know would only get us a small studio in Hawaii. But the lesson learned can be translated into larger purchases. Double the numbers, and you would have an indication of what the savings would be on a $400,000 condo or townhouse.
Of course, interest-only loans are not for everyone. I would highly recommend that you speak with a tax professional or financial adviser to help you decide if this type of loan would be best for your particular circumstances.
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A Tale Of Two Brothers
Adapted from the book, The New Rules of Money
Our story begins with two brothers, each earning $70,000 a year. They each have $40,000 in savings and both are buying $200,000 homes.
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Brother "A" believes in "The Old Way" - paying off the mortgage as soon as possible |
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Brother "B" believes in "The New Way" - carrying a big, long mortgage |
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15-YEAR MORTGAGE AT 6.38% APR |
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30-YEAR INTEREST-ONLY LOAN AT 7.42% APR |
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$40,000 BIG DOWN PAYMENT |
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$10,000 SMALL DOWN PAYMENT |
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$0 LEFT TO INVEST |
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$30,000 REMAINING TO INVEST |
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$1,383 MONTHLY PAYMENT
(56% IS TAX DEDUCTIBLE FIRST YEAR/33% AVERAGE) |
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$1,175 MONTHLY PAYMENT
(100% IS TAX DEDUCTIBLE FIRST 15 YEARS/64% AVERAGE) |
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$1,227 MONTHLY NET AFTER-TAX COST |
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$799 MONTHLY NET AFTER-TAX COST |
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SENDS $100 MONTHLY TO LENDER IN EFFORT TO ELIMINATE MORTGAGE SOONER |
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ADDS $100 MONTHLY TO INVESTMENTS, PLUS $428 SAVED FROM LOWER MORTGAGE PAYMENT WHERE ACCOUNT EARNS 8% RATE OF RETURN |
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Results After 5 Years
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RECEIVED $14,216 IN TAX SAVINGS |
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RECEIVED $22,557 IN TAX SAVINGS
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HAS $0 IN SAVINGS AND INVESTMENTS |
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HAS $83,513 IN SAVINGS AND INVESTMENTS |
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What if both brothers suddenly lost their jobs?
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HAS NO SAVINGS TO GET HIM THROUGH CRISIS |
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HAS $83,513 IN SAVINGS TO TIDE HIM OVER |
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CAN'T GET A LOAN - EVEN THOUGH HE HAS $74,320 MORE IN EQUITY THAN HIS BROTHER - BECAUSE HE HAS NO JOB |
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DOESN'T NEED A LOAN |
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MUST SELL HIS HOME OR FACE FORECLOSURE BECAUSE HE CAN'T MAKE PAYMENTS |
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CAN EASILY MAKE HIS MORTGAGE PAYMENTS EVEN IF HE'S UNEMPLOYED FOR YEARS |
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AT THIS POINT - IT WOULD BE A FIRE SALE - HE'D HAVE TO SELL QUICK, AND AT A DISCOUNT |
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HAS NO REASON TO PANIC SINCE HE'S STILL IN CONTROL - REMEMBER... CASH IS KING! |
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Results After 15 Years
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RECEIVED $25,080 IN TAX SAVINGS |
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RECEIVED $67,670 IN TAX SAVINGS |
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HAS $30,421 IN SAVINGS AND INVESTMENTS |
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HAS $282,019 IN SAVINGS AND INVESTMENTS |
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OWNS HOME OUTRIGHT |
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REMAINING MORTGAGE BALANCE IS $190,000 - AND HE HAS ENOUGH SAVINGS TO PAY IT OFF AND STILL HAVE $92,019 LEFT OVER, FREE AND CLEAR |
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Results After 30 Years
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RECEIVED $25,080 IN TAX SAVINGS |
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RECEIVED $107,826 IN TAX SAVINGS |
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HAS $613,858 IN SAVINGS AND INVESTMENTS |
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HAS $1,115,425 IN SAVINGS AND INVESTMENTS |
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OWNS HOME OUTRIGHT |
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OWNS HOME OUTRIGHT - SO STARTS FRESH AND ENJOYS THE SAME BENEFITS ONCE AGAIN
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Realtor vs. "For Sale By Owner"