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Hello again,

Something KitKat said set me to thinking again. She suggested that I calculate what we’d have to pay in interest over the life of the loans. I did that and was not pleased with the numbers, which I think was probably the intent of her advice.

Rounding numbers to make conceptualization easier, I calculated the interest expense on a 15 year $100K loan, a 30 year $100K loan and a 30 year $200K loan. This third loan would essentially be the hypothetical case of taking out an extra $100K in equity.

$100K @ 3.875% for 15 years: $32,019.08

$100K @ 4.0% for 30 years: $71,867.92
$200K @ 4.0% for 30 years: $143,739.21

Those are some pretty big numbers when all is said and done. Then I thought about how much I would extend the payment, pushing it into years when we probably would not wish to have payments to deal with. We gravitate toward KitKat’s desire to not owe money to other people. At that point, the whole idea looked more hare-brained.

However, in those simple calculations I wasn’t capturing the value of the port; the value of that $100K for thirty years wasn’t entering into the calculation. After all, what I’m really proposing to buy with that extra $100K is a set of securities; an asset. They need to be accounted for in some fashion.

The easiest way to do that is to look at their cash flow and incorporate it some way. And thinking about that further, I realized that I’m more like KitKat than I might sound. I do see the value in not owing people money. My first response, if “stuck” with a 30 year mortgage would be to pre-pay on it. That provides another way of looking at the whole scenario. What if the proceeds from the port are applied to the mortgage, accelerating payment of the loan? This is after all, one of the more likely uses we’d choose for the money. The other would be to drip back into the port. This is not income that we need for any living expenses. Those are covered. So, let’s forget the drip and let’s use that income to prepay to see how the numbers work out.

So, one more thought experiment: let’s incorporate that pre-payment into the numbers, and look at the numbers for that hypothetical $200K loan, with $100K used to purchase securities yielding an average of 6%. Assuming an interest rate on the loan of 4%, and a 30 year term, the monthly payment is $954.83. Six percent on $100K is $500 per month.

If you do that, then the numbers look very different. First, the prepayments cut the life of the 30 year loan in half. The term becomes 15.5 years just by pre-paying $500 per month. If you total your payments over 15.5 years, you arrive at a total payment of $269,143.55 on that $200K loan. But, only $176,643.55 was out-of-pocket expense. The remaining $92,500.00 was paid off by the income stream from the port. You’ll have some out of pocket expenses for taxes that will reduce that some. You’d also have greater income expense to deduct from your income that would partially offset. They could be calculated. But, at the end of that 15.5 years, you have a clear title on your house and a portfolio that I’d wager is worth considerably north of $100K, for out of pocket expense of $177K. Accounting at cost, that’s $200K in assets, purchased for $177K, because you accelerated the amortization schedule with the captured interest spread. Plus, you have that port’s income stream in the future.

Compare that to the 15 year $100K mortgage. At the end of 15 years, you have a clear title for your trouble and out-of-pocket expense of $132,752.64. That’s $100K in assets, purchased for $132K. From that perspective, I think you’re ahead on the larger loan; you’ve captured the interest spread on the “extra” $100K, and used it to pre-pay the other $100K in principal for the house. When I checked rates today, I actually found that they had ticked down. Thirty year rates are now under 4% from multiple lenders.

Thanks for all the thought provoking replies. I’m nowhere near a decision, but the responses have made me think about it from different angles that I had not explored on my own.

Peter
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