This week I was inspired by a website that recommended evaluating your net worth by valuing your liabilities with interest payments included. For example, on your mortgage, take your monthly payment and multiply it by the number of payments you have left. That number is truly what you are going to pay for your place. Valuing your obligations this way is a conservative approach and assumes that you will be staying put long term; however, in times like these, this approach seems appropriate.
In light of this article, I did a quick calculation on my outstanding mortgage. I've been paying as much into my mortgage as possible since last February. At times it's hard to convince myself that these payments are a wise option. Rather than grow my asset base now, they reduce future cash outlays. This is kinda boring to me. After all, it really would be more fun to talk about investments in some exciting company I had made. So let's have a look at these extra payments.
Since inception of my mortgage and between regular and extra payments, I've paid $10,495 in principal. Of this figure, $8,911 is extra payments on principal.
First lets look at some theoretical returns I could have earned on that $8,911 over the 18 month life of the mortgage. Since last February, the S&P 500 has experienced 9% gains. If I had invested the entire $8,911 in an index fund at the beginning of the mortgage (an impossible assumption), I would have $9,688 today. This represents $777 of gains. A perfect number and not terrible returns.
Now lets look at the interest side of the equation. Since inception I have paid $4,613 in interest. At this principal number on my mortgage amortization schedule, I should have paid $27,440 in interest. That amounts to savings of $22,827! Effectively, I have invested $8,911 and made $22,827 over 18 months. That is a handsome return of nearly 2.6x. All of this with an interest rate of only 5% on the mortgage.
You could argue that I should contrast my $22,827 in savings with $8,911 invested over the next 28 years. But that wouldn't be fair. I'm continuing my extra payments, which results in only 10 years remaining on the mortgage. To turn $8,911 into $22,827 over 10 years would require annual return of over 9.5%. I'm not confident in that happening.
Long story short, pay your large debts quickly and save loads in interest. Or is my logic all backwards?
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ReplyDeleteSo, I'm not a finance expert and I haven't really thought this through, but here's a thought. If you can afford to make all those extra payments might it not have been better to get a mortgage plan with higher per month payments and a shorter duration? Maybe you could even have gotten a lower interest rate on that, too. What seems odd to me is that you are, in a way, artificially shortening the duration of your mortgage. You wouldn't had to have to pay the interest you "saved" by making extra payments if you had made another deal in the first place.
ReplyDeleteMan, I hope this is coherent. Finance is hard, I guess I should start thinking about that sort of stuff now as well, since I making my own money now...
thats a very good point. mortgages most commonly come in 30 and 15 year variants in the states. because this was my first house and with all the uncertainty around it, i elected to go with the 30 year variety. i have reconsidered changing, but there is a cost associated with that and im not sure its worth it right now. had i known what i know now, i most definitely would have gone for the shorter duration.
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