Paying Off Your Home
Paying Off Your Home Is it better to buy a smaller home and pay it off early or buy a larger home, never make more than the monthly payment, and enjoy the good things in life (luxury cars, fine dining, cruises, boats, and so forth)? ANSWER: Owning a larger home in a new subdivision, driving expensive cars, and having other material items is appealing. But as the following example shows, there are benefits to starting small, spending less on items other than your home, and paying off your mortgage early. Consider the following example. Rick and Nathan are 25-year-old newlyweds who are buying their first homes. Rick buys a new, three-bedroom home in a subdivision for $101,037.
55. He puts $10,000 down and owes $91,037.55, which he finances for 30 years at 8.5 percent. His payments are $700 per month, and he never pays more than that amount.
Nathan buys a smaller two-bedroom home in an older neighborhood for $66,458.12. He also makes a down payment of $10,000, which reduces the amount he owes to $56,458.12. He finances this amount for 30 years at 8.
5 percent. Although his payments are lower than Rick's, he also pays $700 per month, which means he will pay off his home early. In the first month of payments, the schedule for both men is as follows. Month Name Balance before Payment Payment Interest Principle Total Equity 1 Rick $91,037.55 $700.
00 $644.85 $55.15 $10,055.15 1 Nathan $56,458.12 $700.
00 $399.91 $300.09 $10,300.09 Notice that much more of Nathan's payment goes to principal, which will reduce the life of his loan. After 120 months (10 years), his last payment is made.
Meanwhile, most of Rick's payment is still going to interest, and he has very little equity. Month Name Balance before Payment Payment Interest Principle Total Equity 120 Rick $80,789.33 $700.00 $572.26 $127.
74 $20,375.96 120 Nathan $695.06 $699.98 $4.92 $695.
06 $66,458.12 Nathan sells his home for $66,458.12 and buys the home next door to Rick for $101,037.55. He puts down all the money he made on the sale of the first home, which leaves him owing $34,579.
43. Once again, he finances for 30 years at 8.5 percent interest. Although his payments are lower, he again pays $700 per month, and like before much of his payment is going toward principle. Month Name Balance before Payment Payment Interest Principle Total Equity 121 Rick $80,661.
59 $700.00 $571.35 $128.65 $20,504.61 121 Nathan $34,579.
43 $700.00 $244.94 $455.06 $66,913.18 At the end of 182 months (15 years, 2 months), Nathan's second home is paid for, but Rick still has a long way to go.
Month Name Balance before Payment Payment Interest Principle Total Equity 182 Rick $70,888.30 $700.00 $502.13 $197.87 $30,347.
12 182 Nathan $8.46 $8.52 $0.06 $8.46 $101,037.
55 After paying off his second home, Nathan continues to set aside $700 per month, which he invests at 8 percent. At the end of 360 months (30 years), when Rick's home is finally paid for, Nathan's investment has grown to $239,227.24. In addition, he has the equity in his home, which amounts to $101,037.55.
Thus, he has a total equity of $340,264.79. Rick's only equity is the value of his home, which is $101,037.55. During the past 360 months he has paid $117,257.
92 in interest. Nathan, on the other hand, has paid only $35,670.95 in interest.