Debt Reduction Is Not The Path To Wealth Creation
Coming from European parents, especially my Dutch father, paying off debt was probably the most important financial truth instilled in us at an early age. You never owed people money. You always paid your credit card off 100% every month. And you worked hard to be mortgage free as soon as possible. But what if this wasn’t the best advice? The banks are still encouraging us to quick pay our mortgage, make extra payments etc. We will save so much in interest costs right?
Let me first say, that the bank will never promote an idea or concept that is not beneficial to them. Their first obligation is to their shareholders … not their customers. Sure, you may save interest costs … but you won’t come out ahead.
Let me prove it.
Let’s say you have a mortgage balance of $600,000. The interest rate we will use is 3%. You have 2 choices: 1. A monthly payment of $4,143.49 for 15 years. OR 2. A monthly payment of $2,529.62 for 30 years. The difference in the payment is $1,613.87 per month.
In scenario 1 after the 15 years is up you can save $4,143.49 for 15 more years. In scenario 2 you can save $1,613.87 per month for 30 years.
At the end of 30 years which scenario is better? Assuming an investment rate of 3% … THEY ARE EXACTLY THE SAME! In both scenarios you have a paid off home and investments worth $940,459.
So if they are exactly the same, which should you do? Well the correct decision depends on your answers to these questions…
- If you or your spouse lost your job which mortgage payment would you rather be on the hook for?
- If you became disabled and unable to work which mortgage payment is easier to manage?
- If you or spouse died, which payment would you prefer to leave them with?
- Do you think you could find an investment earning more than 3% over the next 30 years?
- If interest borrowed for an investment are tax deductible, so if you were able to lower your interest costs which scenario would you be better off with?
If you’d like to better understand how longer amortization periods or refinancing can make you wealthier … let me know. I’d be happy to show you how.