Archive for February, 2010

PAY OFF MORTGAGE OR INVEST? CRUNCHING THE NUMBERS.

February 10, 2010

I have read a lot of subjective articles and on the issue, so I have decided to do the math.  Paying down my s mortgage is a safe way for me to diversify my retirement investments.  I also believe that investing in the stock market is an important part of my overall strategy, but paying down my mortgage ensures that I am not putting all my eggs in one (risky) basket.

The easiest way to invest in the S&P 500 is to purchase shares of SPY.  SPY is a high-volume Exchanged Trade Fund (ETF) whose  inception date was January 29th, 1993.   SPY seeks to correspond generally to the price and yield performance, before fees and expenses, of the S&P 500 Index.

Simulation Information

To keep it simple, I have chosen to ignore trading fees but consider SPY’s average 2.5% dividends.

Start Date: 01/29/1993 (spy’s first trading day)

End Date: 02/23/2010

Number of trading years: 17

Dividends:  Every 12 months, my simulation deposited 2.5% of the market value into the account.

Monthly deposit into simulation trading account = $300  (I deposited $300 on 01/29/1993 and $300 on the first of every month from there on.  I kept my monthly contributions at $300 for the entire 17 years of simulation.  I kept it at a fixed investment amount because mortgage rates are also fixed.)

Results

Total Invested = $61,800

Total # shares purchased during the 17 years of simulation = 914

Current account value at $110.67 per share (that was SPY’s closing price on 02/25/2010 when I ran my simulation) = $100,414.98

Total return in 17 years = $38,614.98.   That’s a a total return of 62.48% in 17 years.

We would be in bad shape because it’s an average of 3.7% return per year.  At3.7% return average per year, our gains would have been outpaced by inflation whose rate is substantially higher than 3.7% per year.

MORTGAGE

Now let’s assume that we got a 30-year, fixed-rate mortgage at the very low rate of 5% 17 years ago (that rate did not exist back then).  Let’s borrow $100,000.  During the 17 years, we would have paid only paid the minimal payments.  The $300 extra money we had each month was used in the stock market while we only made the minimal payment of $536  (principal + interest).  After 17 years, we would still have 13 years left in our mortgage.   We would still have an unpaid balance of $61,487 left.

Now let’s go back in time and, instead of investing the $300 a month in the stock market, let’s apply it to our mortgage principal.  WE WOULD HAVE PAID IT OFF IN 2006.

But back in 1993, our mortgage rate would be 7%.  At 7%, the numbers look astronomical.  For our 30-year mortgage, if we paid only the minimal payment while investing our extra $300 a month, we would pay a total of $139,508 in interest in the life of the loan.  If we apply our $300 extra money towards our principal, we would again have paid off our mortgage in 2006.

So, the property that we purchased 17 years ago for $100,000 would be worth how much today, 17 years later.  (In my case, I know that the house that I purchased back in 1998 (that’s not even 17 years ago) is worth tens of thousands more today.)

Real estate as an investment

If you Google “housing prices chart,” you come across a site called investmenttools.com.  (I AM NOT AFFILIATED WITH THEM.)  And here’s their chart showing the historical housing prices in the United States.  You can see that real estate has been a solid investment vehicle even considering the recent drop in prices.  Our $100,000 property which we purchased 17 years ago would be worth substantially more today.

(I AM NOT AFFILIATED WITH INVESTMENTTOOLS.COM.)

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2010/02/05: Payday! Detailed financial planning. Getting ahead of schedule with my mortgage, long-term emergency fund, etc.

February 5, 2010

Today is that much-cherished payday for me.  Here’s what I’ve done today as soon as money showed up in my checking account:

1) Took 50% of my wife’s paycheck (50% is $205.50) from earlier this week and sent to our long-term emergency fund.  That is what is called PAYING YOURSELF FIRST.  That’s a checking account we have setup with IngDirect.com.  That’s a a high-yield savings account.

2) Took the other half of my wife’s paycheck (the $205.50 that was left) and transferred it to a special savings account where we are saving money to visit our families overseas next year.  To us that is as necessary as air, and we are trying to go every 3 years or so.  We do not go into debt for vacation!!

3) This is February, month two.  On month 1 (January), I sent two separate mortgage payments.  My next mortgage payment is due on March 1, 2011.  That is 13 months from now.  That is an important part of my long-term protection plan.  If I lose my job, I want to make sure I have plenty of time to find another job.  Can you imagine having to worry about making mortgage payments while you have no income?  I can’t even imagine!  This month (month # 2), I will make a single payment, which will be the next payment (of March 2011) plus the principal of the following month.  By checking my mortgage amortization table, it means that I will include an extra $816.  I will submit the mortgage payment on my next paycheck two weeks today, on February 19th.  Total that will be paid towards my March 2011 payment = $1,640.64 (March 2011’s normal payment) + $816 (April 2011’s principal) = $2,456.64.    That is how I am going to finish my mortgage very early!!!  In March (month # 3), I will be once again submitting two separate payments.  My goal is to be two full years ahead of schedule in order to have that much protection in case of an extended job loss, which unfortunately is not impossible, not in the new and more socialist economy.