February 2, 2012

Keeping a Mortgage for Greater Investment Gain

home red
Some Financial Experts have the opinion that you should keep a longer term mortgage at a low interest rate in order to invest the difference.  The difference being the lower monthly payment and the idea being that you are using other peoples money (OPM) for your own investment gain.  In order for this to work, the investment rate of return must be higher than the interest rate on the mortgage.  I’ve often wondered how the numbers would play out, but I never took the time to run them.... until now!


My inspiration to run these numbers and write this post came as a result of a comment left by Barbara on my post, Don’t Be Stupid!  Get the 15-Year Mortgage.  In that post, I argued the merits and benefits of getting a 15-year mortgage versus a 30-year.  I only looked at the mortgage side of the equation in that post though.  Here, I want to compare the numbers assuming the difference is invested.

The Assumptions
These numbers are probably pretty close to average for a mid-western family in America.  Say, after everything else is paid, the household budget allows for $1,500 to cover buying a house and investing.  We will assume that this number will stay the same for the entire 30 or 40 years.  Just pretend that cost of living raises will cover just that, cost of living expenses such as gas, groceries, insurance, utilities, etc.  So, average family wants to buy a house for $150,000.  They plan to invest monthly the difference that is left after the house payment is made.  For this example, only minimum mortgage payments will be made for the life of each loan.  Also, I am using 10% as the investment rate of return.  If you want to argue with my 10% assumption, please do so in the comments section of this post.  I put two different sets of interest rates in my tables.  Typically, 15-year mortgages have lower interest rates than 30-year.  The first two columns show rates around 3%, which is pretty close to current market rates at the time of this writing.  The last two columns show rates around 7%, which is probably closer to average over a long period of time.

Mortgage calculations done on calculator provided at Bankrate.com
Investment calculations done on calculator provided at DaveRamsey.com


Investing vs. Mortgage Loan for $150,000 - First 15 Years
Mortgage Term and Rate
15-Year @ 3.0%
30-Year @ 3.5%
15-Year @ 7.0%
30-Year @ 7.5%
Minimum Monthly Payment
$1,036
$674
$1,348
$1,049
Difference left to Invest
$464
$826
$152
$451
Loan Balance after (15 yrs)
$0
$93,822
$0
$112,798
Interest Paid after (15 yrs)
$36,457
$65,738
$92,684
$152,635
Investment Balance (15 yrs)
$193,917
$345,205
$63,525
$188,484



Investing vs. Mortgage Loan for $150,000 - Second 15 Years
Mortgage Term and Rate
15-Year @ 3.0%
30-Year @ 3.5%
15-Year @ 7.0%
30-Year @ 7.5%
Minimum Monthly Payment
paid in full
$674
paid in full
$1,049
Difference left to Invest
$1,500
$826
$1,500
$451
Interest Paid after 30 yrs
$36,457
$92,484
$92,684
$227,576
Investment Balance (15 yrs)
$193,917
$345,205
$63,525
$188,484
Investment Balance (30 yrs)
$1,490,577
$1,882,722
$909,820
$1,027,976
Investment Balance (40yrs)
$4,344,883
$5,406,436
$2,772,747
$3,092,603


Assumptions Don’t Always Work Out
All of the above numbers look great on paper, but we all know that life rarely happens exactly the way we plan.  Something unexpected is always going to come up that will affect either your income or your expenses.

The biggest argument I always get revolves around my investment return expectation assumptions.  For example, if you were to run the numbers on average growth stock mutual funds for the 15-year period from 1997 to 2012, you probably wouldn’t hit 10%.  My assumptions are based on averages over longer periods of time.  So yes, returns could be really low for 10 years and then really high for 10 years.  In either case, we don’t really know for sure what is going to happen in the future.  We can only base our assumptions on the performance in the past.

One thing that is predictable though, is the interest you will pay on your mortgage.  That rate doesn’t change, unless you were foolish enough to sign up for an adjustable rate mortgage.

Analyzing the Math
To my surprise, the math actually works out in favor of the advice that many so-called experts and financial planners give out.  This is further proof of the incredible power of compound interest!  With both sets of mortgage interest rates, the math comes out in favor of getting the 30-year mortgage and investing the difference.

The argument is much stronger with these amazing 2012 mortgage interest rates.  In this example, the person who takes out the 30-year mortgage ends up more than one million dollars ahead of the person who gets the 15-year.  Even with mortgage interest rates around 7%, the 30-year wins, although only by about $300k over 40 years.

After running the numbers and seeing the results clearly laid out, I can understand why so many people fall for this.  Some financial planners even go as far as advising their clients to keep refinancing and keep their mortgage for their entire lives in order to leverage their investing using other peoples money.  It seems like a win-win-win situation.  The bank wins because they collect far more interest from the homeowner.  The investment adviser wins because they collect higher commissions over a longer period of time.  The homeowner/investor wins because they end up with more money in their investment accounts.

Personal Finance is Not Only About the Math
Despite running these numbers myself, seeing them with my own eyes, computing them in my brain and publishing them on my blog, I still would not advise the 30-year mortgage.  But then again, I am not an adviser, so don’t take my advice.  Just telling you my thoughts and opinions and what I have learned over the years.

I am personally working hard to get my home paid off as soon as possible.  I am currently on a 15-year loan and can’t wait to see what it feels like to live in a home that is paid for in full!  I know the difference in what it feels like to drive a paid for car as opposed to one with a loan.  I can only imagine that feeling is magnified for a paid for home.

Think of it this way.  If you worked hard your entire life and paid on a mortgage until it was paid in full, would you then go get a mortgage on it in order to invest?  That’s pretty much the same thing as keeping a mortgage in order to invest.  No.  I want a paid for house.  I want to know the feeling of being 100% debt free.  I don’t want to owe a dime to anyone for anything.

I don’t care if the investment numbers work against me, because there is one thing that you can’t put a price on.  Freedom!  When you don’t have debt, you have freedom.  When you keep debt, you are anything but free.  You are a slave to the lender. (Proverbs 22:7)  In this case, the price of freedom is a few hundred thousand dollars, or even more than a million dollars in investment returns.  No thanks!  I’ll pay that price and take freedom every single time.

Readers:  What is your take?  Do you pay more attention to the math side of this equation or the personal side?

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