Chris, an employee of Dave Ramsey and a blogger at Pour Out, left this comment on yesterday’s Dave Ramsey post about mortgages (I truncated Chris’ comment in order to emphasize what I want to talk about):
He [Dave] doesnâ€™t want you to pay off your home in 15 years; He wants you to pay it off in 12 years, or 10 or 7 or 4!!! Add those extra years of investing the $1700 house payment monthly and itâ€™s probably a different picture. Digest the entire plan, not just bits and pieces, and youâ€™ll end up ahead of the family in that right column. Good conversation you have going on here.
What would happen if you paid off a 15-year mortgage in 4 years? Would that change things? Let’s see…
In order to do this little calculation, I had to make some assumptions:
1. Taxes are ignored. There’s too many tax brackets and too many different scenarios. So, I decided to ignore taxes on both investments and the deductibility of interest.
2. I used the interest rates of 6.08% for the 15-year mortgage and 6.30% for the 30-year mortgage from yesterday’s post.
3. To pay off a $200,000 mortgage in 4 years, it would require an additional payment to be made of $3,000 per month, bringing the total monthly payment for the 15-year mortgage to $4,696 . The monthly payment for the 30-year mortgage would be $1,238.
4. I assumed that both families had an extra $3,000 per month. The family with the 30-year note is investing their $3,000 per month and getting an average return of 8% per year (or .67% per month).
5. After the 4 years is up, the family that paid off their mortgage early invests their entire payment of $4,696 per month and also gets an 8% annual rate of return.
Here’s what I came up with:
This all boils down to the fact that we have to make choices as to where we allocate our money. These choices involve picking one “return” for another. If you choose to pay an extra $3,000 per month on your house note so that you can be mortgage free in four years, then you also are making the choice NOT to invest the money elsewhere. This kind of thinking requires you to look at your personal finances like a business owner looks at their business.