Home ownership is part of smart money management
by Hugh Hardy
It's amazing how easy it is to work year in and year out and never have anything to show for it. If this is your situation - then you are in the majority! But it doesn't have to be this way. Just read the financial planning books. These books tell us over and over again that there is very little difference between those who have managed to save money and those who find that they just can't do it! It is my intention to expose the common kernel of wisdom that can be distilled from many of these financial strategies and to show how home ownership - whether you currently own or plan to buy in the future - will dovetail perfectly with your plan to create a "nest egg".
For most people, budgets are not the way to save money for a nest egg. I think that we can say that budgets are like diets - they don't usually work! Try budgeting for a while, and you might find that you re-bound twice as hard, as soon as the purse strings are loosened a bit. That's much like a diet, for sure. So what can we do about this situation? According to the experts, we must create an idiot-proof system that will guarantee a certain financial outcome - no matter what. These money gurus say that it is simply a consistent effort - a small monthly commitment to saving - that is the difference between the "haves" and the "have-nots". And it's basically executed through a system of forced savings. From what I can see, it's a two-pronged approach that works best. There's a cash savings component - perhaps as a compound interest RSP or GIC - and there is a home ownership component. By owning your home outright at the end of 10 or 20 years, you have laid the cornerstone of your nest egg. One of the nice things about making your home part of "the plan" is that everyone needs somewhere to live and must pay some kind of rent anyway. This money might as well be working for us - rather than padding someone else's pocket!
So the gist of the system is that, no matter what, we always make our monthly mortgage payment and our small RSP contribution. These are the first things that get paid. Using an automatic withdrawal from the bank is a great way to make it inflexible and "idiot-proof". That way, "The Plan" can't be tampered with! So, as long as you can remain financially solvent, you're guaranteed to have your house paid for and a sizable nest egg in twenty years or less - whatever timeframe you set for yourself. Let's see what makes that small monthly savings become so sizable over the years. I'll briefly go over one example to show you how compound interest can exponentially increase savings with only a small outlay each month, and then I'll tackle the best way to deal with home ownership. It may seem outrageous, but an investment of $200 per month, over 30 years, at an average return of 15% per year (smart investing will create this rate of return), will generate a nest egg of 1.4 million dollars! That's right, 1.4 million dollars!!! Don't take my word for it, these figures are straight out of the Canadian financial planning book; "The Wealthy Barber". Of course, $200 per month may be more than you can afford, so start with a smaller figure, and contribute consistently. The results will still be dramatic over time.
Now let's talk about how to set your mortgage up for the best long-term results. No doubt, you have heard all the suggestions as to the best way to structure your mortgage. The banks scream at us. "Pay weekly". "Pay bi-weekly". "Double-up your payments". "Amortize over 15 years". Forget all the hype! All these payment options can be distilled down to one simple issue - "what's the amortization?" If you can minimize the length of time that it takes to pay the mortgage off (this timeframe is called the "amortization"), then the total amount of interest paid over the course of the loan will also be minimized. All the different payment options mentioned above have different amortizations attached to them. It is only the amortization number that has any ultimate significance to the smart borrower. For example, paying weekly just means that you make the equivalent of 13 monthly payments per year because there are more than 28 days in the average month. This shortens the amortization period, and consequently, the total interest paid.
In plain English - and this is ALL you have to know - "pay off the mortgage as fast as you can handle and you'll pay dramatically less interest!"
Let's look at some numbers. Assuming that we are dealing with a $100,000 mortgage and an interest rate of 7% per year, we can vary the amortization period and look at the total interest paid as well as the monthly mortgage payment. If we pay the loan over 25 years, the monthly payment is an easy $700, but the interest paid over the 25 years is a whopping $110,123! It's no wonder that the banks are smiling when we sign our mortgage papers! If the amortization is reduced to 20 years, the payment is only $69 more per month, but we have now saved $25,488 in total interest over the 25 year amortization! A 15 year amortization would mean a monthly payment of $893 with a total interest payment of $60,785 over the course of the loan. Finally, a 10 year amortization would mean a monthly payment of $1156, and a total interest payment of $38,713.
My suggestion is to forget all the cute ways of paying and simply set up the largest payment that you can afford (whether it's monthly or weekly or bi-weekly should only be according to convenience). There aren't too many banks that are keen to push this approach. They'd never say: "Pay that mortgage to zero as fast as possible!" After all, it's the banks that keep making billion dollar plus profits every year - and they want you and me to give them as much help as possible!
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