I struggle with this simple math problem. Others on BITOG will not- but I do.
Eight months ago, Wife and I purchased a home. The home had an assumable solar loan, original balance of $50k USD, we assumed the balance of $48k USD, 1.99 percent interest, for 30 years ($212 monthly payment). The original purchaser of the solar likely overpaid, and the solar parts and labor should have been in the $15-20k USD. It appears the purchaser of the solar received a check from U.S. taxpayers for $15k USD, solar rebate. The original purchaser of the solar likely went for the deal, as their electric bills were about $200 USD monthly. So, install solar, reduce your electric bill from $200 to $12 per month, and get a check in the mail courtesy of U.S. taxpayers for $15k.
So, here is my dilemma. Pay off a $48k loan, on a solar system that new should have cost no more than $20k USD? I have the money set aside to pay off the loan at any time (currently earning four percent at a NCUA insured financial institution). I am very tempted to pay the loan off. Or keep making payments, for 28 more years, where the total interest over 28 years will likely be in the high five figures.
I know the expert/ savvy/ smart money method is to keep the money in the bank, make four percent interest, and keep making the payment. But I am not so smart and hate paying potentially a high five figures in interest.
Caveman GON here.
The interest rate plays into it, I’m sure. Someone with excel and a bit of time could plot it out nicely, I’m sure.
Good scam too. Buy something overpriced on the basis of getting some back on taxes, don’t use the amount back to pay the loan, let the next person assume the whole amount. I probably would have tried to negotiate for the payment to be made, or equivalent in-kind.
Why? It’s a feeling I am glad you admit that. But it’s not always the best financial decision.
I struggle with this argument if one is not sitting on a lump sum. So I want to do the thought exercise. I think it may indicate that real estate ownership is never a good option, assuming markets continue to rise.
If one had a lump sum, and I’m just going to make up numbers for the thought exercise… say one has $500k.
Assume that over time the S&P does indeed return 10% p.a.
And say someone has to live somewhere, and they could buy for $500k cash, mortgage at 3% or 6.5%, or rent.
IF you had the lump sum and could earn 10% vs paying 3 or 6.8%, ok that makes sense. You’ll net some return, even if some down years you lose a bit.
But if you don’t have the lump sum, like most folks, one is cash-flowing their mortgage payment, and is not making big returns on big money from day one.
So let’s assume $500k property bought cash, or mortgaged $100k down. And I’ll calculate without any taxes, insurance, etc.
At 6.8%:
At 3%:
$400k invested into the S&P at 10% p.a. For 30 years:
Pretty compelling. But most retirees won’t live 30 years, and most young folks don’t have a lump sum.
So say you didn’t use $100k on hand to buy and mortgage a home, but instead invested it, and since you still have to indefinitely pay to live, imagine you can find cheap rent, and your ability to save never exceeds $250/mo… then:
$2.26M is still pretty compelling. One can argue that the $500k home will be worth considerably more in 30 years… sure. That’s fair. But quadruple? And then deduct the years of (rising) property tax, upkeep, insurance, etc.
Doesn’t seem to be very compelling, regardless of RE returns. Remember that the person mortgaging the $500k home with 20% down and a current rate of 6.68%c is paying more than the homes initial value in interest! Vaporized. Of course, you do need to always live somewhere, and generally don’t want to be victim to the whims of another, or make payments on their asset.
But the argument is always hard to wrap a head around based upon numbers. This would imply, which is what I think we are seeing, that the best bet is to minimize a long term mortgage interest rate, and just sit on it, investing the difference. Ownership for the sake of ownership is not sensible, assuming you can actually take advantage of a viable long-term return.
In the same case if you have to go conservative because of age, and average lower over time….
$100k invested with $250/mo at 4%:
Far, Far less compelling.
And for the retiree, who needs to be conservative, but might have a lump sum.. ok, invest the $400k and never any more, at 4%:
I’d suspect it’s almost guaranteed that the home will be worth more than that in 30…. And while this number is a decent chunk of change, subtract from it the $200-500k of interest that is vaporized. All of a sudden, the net is just plain awful vs just buying outright. Certainly versus renting, since the mortgage will be a level payment other than tax and insurance, while rent is guaranteed to rise. That means the likelihood of more free cash into the future is more guaranteed with an owned home or at least a long term mortgage.
So for the young person with a windfall of cash, renting or keeping a mortgage may be smart.
For a retiree? Maybe not so much…
