Real Estate, Finance and Home Articles of Interest

So that the masses can cut down the time that it takes them to pay off their loan and reduce the total amount of interest forked over over that period, banks and financial advisors recommend that borrowers hand over extra each month.

For example, if you borrow $200,000 over 30 years at a rate of 5%, your monthly payments would be around $1074. Over the next 30 years, you would make 360 payments (months) of $1074 for a grand total of $386,640. That's $186,640 more than the original loan!

Now, the reason that banks and financial advisors tell you to hand over more is that because if you could hand over an extra $246 a month with a total of $1320 going toward your mortgage each month then you would cut 10 years off your mortgage payment period. You would save $69,756 over the course of the loan and reduce your total payments to $316,664.

Of course, the title of this article is not "Why You Should Fork Out More Every Month" and it is about actually forking over less each month. So, now I am going to show you why forking over extra each month, while better than making regular payments, is not the best way to pay off your house and actually make money. The flaw in this technique is that it ignores the time value of money.

That said, let me first explain why financial advisors and the banks preach what they do before we get into the time value of money. It's pretty simple when talking about the banks. It's less risky to them and they make a lot more money by lending the money to others when you pay your mortgage early Because the homeowner that has PAID MORE money toward their mortgage is less risky for the bank, the bank prefers to target them first. This is completely the opposite of the belief that the bank won't target the masses that have forked over a lot more money. In actuality, homeowners are actually safer from foreclosures when they OWE MORE money.

The Hilton Hotel empire is probably the best example of this. During the Great Depression, when homes were being foreclosed on left and right, the Hiltons did not have one property foreclosed on even though they fell behind in the payments several times. Basically, they made sure that the banks would not target them since they owed so much money (and still do since they never pay off their properties.)

Financial advisors often tell their clients to go this route and I have no idea why. They know that the banks first target those that have forked over a lot more money. Finally, having their clients pay off their mortgage actually costs their clients and themselves (because they get paid by making their clients money) a ton of lost profit because of the time value of money.

Everyone knows that money is worth less now than it was when they were younger. If you take that $1074 mortgage payment, for instance, in 30 years time, when the last is due, it would only be worth $437 in today's money.

A dollar now is always better than a dollar in a year's time, or in 10 year's time.

So, in our example, how does the time value of money affect everything?

It's not as simple as just subtracting the mortgage interest amount being saved from the 30 year mortgage. To truly determine the best choice, you need to calculate the "Present Value" of each mortgage option.

The Present Value of a 30 year mortgage fixed at a 5% interest rate and with a mortgage payment of $1074 is $200,066.

The Present Value of a 20 year mortgage with a mortgage payment of $1320 at a 5% interest rate is $200,066.

The two repayment schemes are exactly equal.

In truth, that $246 per month adds up to $59,040 over 20 years so you are not really saving $69,756 but rather about $10,000.

Now, what would happen, for example, if you took that $246 a month and invested it elsewhere in something safe and conservative like a mutual fund?

Averaging a 10% rate of return, you would have $186,804 (Note: an S&P 500 Index Fund would be an excellent choice as the S&P 500 has average a 10.83% rate of return over the last 50 years.) That would be worth about $102,597 in today's money with inflation hovering around 3%.

Now let's ask the question we asked once before to get even more answers. Surely, the longer the income stream lasts, the better, right? So why would the banks recommend that you pay off your mortgage a lot more quickly?

"Our recommendation will save you money" is one thing that the banks love to prove and make it seem like they are only doing it for your benefit. But in reality, the banks really understand the time value of money. The banks know that $246 today is worth a lot more now than it will be in 20 years.

There are some arguments for paying your mortgage back quickly - for one thing, the quicker you hand over, the quicker your equity grows. But you should understand that every dollar you give the bank now is a dollar that you can't invest.

Why give up your right to have your money safely and conservatively make you 10-30% to save 5%. Doesn't that sound pretty stupid? How would you like to pay off your home in less than 15 years and also walk away with a little over $60,000 for every $100,000 that you initially borrowed. I show my clients how to do this every single day!

Finally, many people have a misconception about the wealthy that I want to dispel. Most unwealthy people believe that wealthy people don't have mortgages and that they own their homes 100%. The fact of the matter is that most do not own their homes free and clear because they understand that their money can make them a lot more money in other investments rather than sitting in the walls of their homes. Major corporations like Home Depot and Coca-Cola don't own the land that they operate on and Bill Gates took out a mortgage for his new $65,000,000 home (which he could have easily paid cash for, right?) So, why is Joe Average so eager to pay off his mortgage faster?

Of course the title of this article talks about actually cutting your monthly mortgage payment while building wealth at the same time and I would love to show you how to do exactly that. If you would like to know how to decrease your monthly mortgage payment while at the same time build your wealth then please be sure to contact me.

Ed Brancheau is a mortgage financing virtuoso who can show you to decrease your payments, pay off your mortgage much faster and create wealth. Call him at 310-770-2369 for more info.