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Pleez help - I need advice on which scenario makes more sense

Total cost of a house is $280,000. I am 35. I intend to put down 70,000 and after keeping a fair amount of cash for emergencies I have 40,000 to invest.

Scenario one
Take a 30-year mortgage and invest the 40K in the stock market. After 30 years I will have paid off the house and will have had the 40K growing in the stock market

Scenario two
Take a 15-year mortgage which I cannot afford unless I use 5000 a year from the 40,000. After 15 years. I will have paid off the house but will then have none of the 40K left – however I will then have the next 15 years to save and invest as I will have no mortgage. The house and mortgage will also have cost me a lot less

Thanks in anticipation

Craig
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craigdoc asks,

Pleez help - I need advice on which scenario makes more sense

Total cost of a house is $280,000. I am 35. I intend to put down 70,000 and after keeping a fair amount of cash for emergencies I have 40,000 to invest.

Scenario one
Take a 30-year mortgage and invest the 40K in the stock market. After 30 years I will have paid off the house and will have had the 40K growing in the stock market

Scenario two
Take a 15-year mortgage which I cannot afford unless I use 5000 a year from the 40,000. After 15 years. I will have paid off the house but will then have none of the 40K left – however I will then have the next 15 years to save and invest as I will have no mortgage. The house and mortgage will also have cost me a lot less

Thanks in anticipation


I took Scenario 3. I continued to rent a cheap apartment, put all my money in the stock market, and retired in 1994 at age 38. <grin>

As far as scenario 1 or 2, it depends on if the stock market grows faster than the interest rate on your mortgage. If you look at the one hundred 30-year holding periods between 1871 and 2001, the best grew at an average of 13.40% per annum, the worst was 5.13% per annum, the median was 9.37% per annum.

intercst
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intercst:

[craigdoc asks]

<<<<<Pleez help - I need advice on which scenario makes more sense

Total cost of a house is $280,000. I am 35. I intend to put down 70,000 and after keeping a fair amount of cash for emergencies I have 40,000 to invest.

Scenario one
Take a 30-year mortgage and invest the 40K in the stock market. After 30 years I will have paid off the house and will have had the 40K growing in the stock market

Scenario two
Take a 15-year mortgage which I cannot afford unless I use 5000 a year from the 40,000. After 15 years. I will have paid off the house but will then have none of the 40K left – however I will then have the next 15 years to save and invest as I will have no mortgage. The house and mortgage will also have cost me a lot less

Thanks in anticipation>>>>

"I took Scenario 3. I continued to rent a cheap apartment, put all my money in the stock market, and retired in 1994 at age 38. <grin>

As far as scenario 1 or 2, it depends on if the stock market grows faster than the interest rate on your mortgage. If you look at the one hundred 30-year holding periods between 1871 and 2001, the best grew at an average of 13.40% per annum, the worst was 5.13% per annum, the median was 9.37% per annum."


I think it slightly more complicated.

In scenario 2, the 40k runs out somewhere after year 8 but before year 15 (probably before year 10, but I am too lazy to run numbes now), so how is the mortgage timely paid thereafter?

Also, it also involves the risk of market returns in first 15 years vcersus second 15 years when entire house payment could be invested, and volatility is greater when periods are shorter. I suspect we could construct a scenario that returned more by 15-year loan without violating reasonablebounds, but probability would I suspect be low (assuming other income to pay mortgage for 30 years).

For Rayvt (I know that you disagree) about almost ever paying the house off early (even using 15 year mortgge instead of 30 year mortgage); some argue that mortgage is generally least expensive money available for LT borrowing and therefore maximize loan for as long as possible.

Regards, JAFO




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Scenario one
Take a 30-year mortgage and invest the 40K in the stock market. After 30 years I will have paid off the house and will have had the 40K growing in the stock market


How about scenario 1.5? Take a 30-year mortgage and make extra payments so that you pay it off more quickly.

This way, you can start investing earlier and you can still save quite a bit of interest. If your income drops temporarily, you can just make regular mortgage payments. If your income goes up, you can make even more extra payments.
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<<<Total cost of a house is $280,000. I am 35. I intend to put down 70,000 and after keeping a fair amount of cash for emergencies I have 40,000 to invest.>>>

Here are some things to think of. With a thirty year mortage, at it's end, you would have paid about 3 times the cost of the house. That is, principle plus interst. So total cost of your house is around $600,000 since you're putting down $70,000. Now take that $40,000 and invest. You would have to earn around 14% over 30 years to get about $600,000. Even with the historical S&P 500 return at 10%, you're looking to outperform by 4%. I know some of our screens easily do that, but it all comes down to what you're comfortable with.

Me personally, I paid off my mortgage, around 20 years early, and now use my mortgage note to invest. But I only did that with "extra" money, what was left over after funding my retirement accounts and building an emergency fund and retiring all debts.

JLC

who thinks any debt is bad.

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<<<Here are some things to think of. With a thirty year mortage, at it's end, you would have paid about 3 times the cost of the house. That is, principle plus interst. So total cost of your house is around $600,000 since you're putting down $70,000. Now take that $40,000 and invest. You would have to earn around 14% over 30 years to get about $600,000. Even with the historical S&P 500 return at 10%, you're looking to outperform by 4%. I know some of our screens easily do that, but it all comes down to what you're comfortable with.>>>

You should also account for the tax benefits that you get by carrying the mortgage.

Vlad

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I say go with Scenario One...chances are, you may want a new house by then or you will just 'want to move'. so I really think the first choice is your best choice.

charity
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<<<You should also account for the tax benefits that you get by carrying the mortgage.>>>

In the given scenario, you pay about $400,000 in interest over the life of the mortgage. If you are in the highest tax bracket, approximately 40%, that means $160,000 can be "written off" on your tax return. So you've now paid around $440,000 in the given scenario. For the equivalant return, you'd have to get around 10%, the market average. Of course, if you're in a lower tax bracket, you'd have to earn a higher return. So even in the best case scenario, you'd break even, assuming that you got market average.

It still boils down to what you're comfortable with, and if a "bird in the hand is worth two in the bush".

JLC
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<<<In the given scenario, you pay about $400,000 in interest over the life of the mortgage. If you are in the highest tax bracket, approximately 40%, that means $160,000 can be "written off" on your tax return. So you've now paid around $440,000 in the given scenario. For the equivalant return, you'd have to get around 10%, the market average. Of course, if you're in a lower tax bracket, you'd have to earn a higher return. So even in the best case scenario, you'd break even, assuming that you got market average.>>>

Funny how things pop into your head at the gym. I guess working the body allows the mind to freely associate. Also need to take into account the capital gains tax. This 40k couldn't be place into a Roth IRA all at once, so assume it would be in a taxable account. Even if playing the ultimate buy and hold, IIRC, a 10% capital gains tax would apply, therefore, you'd have to have a pre-tax return of around 11%. Therefore, back to the idea of having to guarantee beating the market, albiet by 1%. Question again returns to: Do you want the sure thing or take the chance?

JLC
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I took Scenario 3. I continued to rent a cheap apartment, put all my money in the stock market, and retired in 1994 at age 38. <grin>

As far as scenario 1 or 2, it depends on if the stock market grows faster than the interest rate on your mortgage. If you look at the one hundred 30-year holding periods between 1871 and 2001, the best grew at an average of 13.40% per annum, the worst was 5.13% per annum, the median was 9.37% per annum.


I'm looking to do this, too. My girlfriend and I have talked about owning a home, but we figure that until we're sure we want to stay somewhere 20 years or longer, renting is more cost-effective than buying. We could buy a property and pay for it in five years, but it'll take another 10 years before rent becomes more expensive over the 15-year period. We have equity in the home, but we're forced to keep it to have someplace to live.

Does anyone else find this true? My thesis is that renting is more cost-effective than buying until you stay in the same property for about 15 years, factoring in inflation and increases in rent on one side and additional home expenses on the other.

JBR.
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<<<My thesis is that renting is more cost-effective than buying until you stay in the same property for about 15 years, factoring in inflation and increases in rent on one side and additional home expenses on the other.>>>

I guess it all depends on where you live and your lifestyle. Where I live rent and mortgage on the comparable houses are about the same. Mortgage on a condo is often less than a rent on a comparable apartment. So renting is not cost-effective in my area. However, if you like living below your means and will be content with renting a small apartment in not a very popular area of town or a room, you can save a lot of money compared with either renting or buying a bigger or better place.

I would also avoid paying too much attention to the inflation. From all accounts, we are more likely to be moving towards a defaltionary environment rathen than inflationary. Cash is the king in such an environment so if renting is cheaper for you where you live, you might be better off renting and holding on to your cash.

Vlad
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I guess it all depends on where you live and your lifestyle. Where I live rent and mortgage on the comparable houses are about the same.

I pay Cdn$1200/mth for a two-bedroom, 1000-sq.ft. apartment in a nice part of Toronto. Not chic, but nice. A good-sized condo in and around where I'd like to live is $160k, with about $600/mth in condo fees and property taxes, meaning that I'd need about a 15-year mortgage for the payments to be no more than I have now. I'd hate to pay that much interest, so I'd go about 5-7 years, meaning $2900/mth grand total. In order to have paid the same amount over time as renting, I'd need to stay there about 2-1/2 times as long as I spent to pay off the mortgage, given that the $600/mth expenses don't stop once the mortgage payments do. That's 12-18 years.

There's where my calculations came from, anyway... if there are holes, show me 'em. :) I'd better know now, rather than later.

I would also avoid paying too much attention to the inflation. From all accounts, we are more likely to be moving towards a defaltionary environment rathen than inflationary. Cash is the king in such an environment so if renting is cheaper for you where you live, you might be better off renting and holding on to your cash.

This is certainly a provocative statement. I did a retirement worksheet showing how long I'd have to work and save to my retirement fund to pay for my Golden Years. I factored in an average of 3% inflation over that time. Are you saying that, by doing that, I may be actually overstating the longterm effect of inflation? Any references on that idea?

Thanks.

JBR.
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