Good Money After Bad
Come on! Seriously. You work WAY too hard every day for your money to be throwing it away.
If you are upside down in your house, you owe it to yourself to calculate the long term ramifications. The point of home ownership is a) to have a place to live that’s paid for, b) to build wealth and security for your family, c) to invest and generate cash flow.
As it is, with a 30 year mortgage, your total cost of ownership is much higher than the purchase price of the home. Many people consider a mortgage a forced savings account because part of the monthly payment reduces the total amount owed on the house and becomes equity. If you look at it this way, you also have to realize that during the first 15 years, MORE of your payment, in fact MOST of your payment is paid to the bank in the form of interest and is not “saved.” Your money hardly starts working for you until the latter 15 years.
Let’s look at a simple example.
Bob and Judy purchase a home for $250,000 at 6% over 30 years. Their monthly payment is about $1500.00 per month, and after 30 years, the total amount of interest paid reaches $289,500, making the total cost of ownership, not including deferred maintenance, $539,500. IF the house increases in value over those 30 years by 4% annually, at the end of 30 years, it should be worth approximately $810,000, yielding a gain of $270,500. If you divide the gain by the total cost, you get the investment gain, which is 50.1%. If my math serves me correctly, 50.1% over 30 years is 1.67% annually.
A 1.67% annual gain is not enough to outpace inflation. All things considered, Bob and Judy have a paid for home now, and they don’t have to worry about foreclosure, but the opportunity cost is just too great. Bob and Judy paid more in interest to the bank than the purchase price of the house. How much hard work does that represent? Ugh…it makes me sick to see so much potential thrown out the window.
The example I just outlined is a good standalone argument against 30 year fixed mortgages as it is. But what happens when you purchase a home and the value drops by 50%, which is exactly what happened in Phoenix in recent years.
Well, Bob and Judy’s original 30 year note would still yield the same numbers and at the end of the loan they would have paid a total of $539,500 as I outlined above, but in this case, they would have lost 50% of the original purchase price only 4 years into their 30 year term (2008-2012). What they had originally paid $250,000 for is now worth $125,000.
If over the next 25 years remaining on their mortgage, their home increases in value by 4% annually, at the end of the 30 year mortgage, their home might be worth $333,000 and they will have paid out $539,000 for a total LOSS of $206,000.
Is this all starting to become clear?
There’s a point during the loan term at which your house value and the amount remaining on your note will break even, but it’s at a little more than 10 years in. So for those 10 years you can count your payment as rent to yourself. It disappears. What you really have to pay attention to is the total cost by the end of the 30 year term.
So what’s the point? The point is that it’s time for you to take a look at your current situation and weigh them against your long term plans and the possibility of the unexpected rainy days changing your path. If you know for certain that you’ll be living in your house or owning the home for the entire 30 year term, then the worst that could happen is you’d lose a truck load of money, but you’d have a paid for home. If, however, there’s ANY remote possibility that you would need to move for any reason whatsoever before your house is worth more than you owe, then you need to recognize that every penny you spend on your house now is good money after bad.
In other words, if you don’t choose to short sell your house now, you may be forced to later. Really consider whether or not this is a possibility and then don’t delay on course correcting now.
Regardless of whether or not you choose to remedy your financial situation by paying off your note or short sell your home, you need to take inventory of your financial situation so you can plan your next steps.