The financial world we live in is just as wild, if not more, than the mountains and woods we walk through. We are told that the fundamentals of our economy are strong, but we can feel that something is wrong. My unique financial background and survival passion make Financial Survivalist and excellent place to learn and share.

Monday, December 5, 2011

Why Dave Ramsey is an Epic Fail: 15 yr Mortgage


Dave Ramesy is a great guy. He does a lot of good and helps a lot of people get out of debt. But Dave Ramsey is only a man, a man that is a "Financial Entertainer" for a living.

One of the things Dave always recommends is a 15 year mortgage so that you will save money on interest. Although, this may make sense in some situations, let's take some time to think this through.

A 15 year mortgage will generally carry a lower interest rate. The following interest rates are based on Chase's current interest rates for different products.

A 15 year $150,000 mortgage at 3.375% will carry a monthly payment of $1,063.14.
A 30 year $150,000 mortgage at 4.25% will carry a monthly payment of $737.91.
The difference between these two monthly payments is $325.23.

Interest on the 30 year mortgage is $86,303.46
Interest on the 15 year mortgage is $41,365.16
Interest difference is $44,938.29.
No wonder Dave recommends a 15 year mortgage.

BUT WAIT!

What if you took the difference of monthly payments ($325.23) and paid that directly to principle on a 30 year mortgage? Total Interest =$$58.256.88!!!! The interest difference between the 15 yr and 30 yr is $16,891.72. The 30 year mortgage gets paid of in 16 years and 4 months exactly! Not the same as a 15 year mortgage, but pretty close.

So if you could save $16,891 why wouldn't you? Because it only amounts to saving $1,126.11 per year, and within the next 15 years anything could happen. If you lost a job and started having to live off your emergency fund, it would make a big difference if you could stop paying that extra principle payment every month.

What if you burned through your emergency fund. My father has been unemployed and constantly searching for employment more than a year! What if after your emergency fund was gone and you couldn't afford the higher $1,063/mo payment? It might mean you keeping your house if you can drop your payment back down to $737!

Another thing to consider is tax savings. Most interest on a mortgage is tax deductible. In this example, assuming a federal tax rate of 25%, the tax savings for the 15 year mortgage is $10,341.29; for the 30 year option $14,564.22. The difference is a larger tax savings for the 30 year mortgage of $4,222.93. This cuts the net interest savings for the 15 year mortgage to $12,668.79 or $844.59 per year. That's less than a hundred dollars a month that you're saving in interest. Keep in mind that isn't increased income. It's just savings in interest payments.

The biggest question is weather or not saving $844 a year is worth losing the ability to change how much you MUST pay the bank? If you think that savings is worth it then go for it, but don't blame me when the economy gets worse than it already is and you can no longer afford the higher payment.

If you're not disciplined enough to pay the extra principle, then you probably can't live on a budget either and Dave Ramsey can't help you anyway. If you are a Financial Survivor, then choose the 30 year mortgage. Keep your options open. If paying off your mortgage early is what you want to do, you can set up automatic principle payments. If some unforeseen event happens along the way, then you will have options.

Be Smart and Thrive!

4 comments:

  1. Let's look again at the numbers:

    15 year mortgage: 15 x 12 x 1063.14 = $191365.20
    30 year mortgage: 30 x 12 x 737.91 = $265647.60

    So the total interest you pay is:

    15 year mortgage: 191365.20-150000 = $41,365.20
    30 year mortgage: 265647.20-150000 = $115,647.20

    So the difference between the two is $74,282.00

    The difference of $44,938.29 that you give is maybe the difference you have paid in interest after 15 years? But then you are overlooking that you now own the house free and clear if you chose the 15-year mortgage, while you are still in debt if you chose the 30-year mortgage.

    The only rational reason for choosing 30-year over 15-year is that you lower the minimum monthly payment, but it will cost you more in the end. If you have the means to pay the 15-year payment, that is the better choice.

    Paying an interest rate of 3.375% is better than paying an interest rate of 4.25%. Any mathematics that tells you otherwise should be viewed with extreme skepticism.

    ReplyDelete
    Replies
    1. I see your math and raise you another question. What if you could invest the difference of payments at an interest rate above your mortgage cost? Add the tax savings and let me know which makes more financial sense. Seriously, numbers are my thing, and if the investment is secure, there is no questions what the numbers say.

      Delete
  2. Certainly, if you can invest the borrowed money at an interest rate above the mortgage interest, that is a good deal but the condition that you mention ("the investment is secure") is a very important caveat.

    Paying off the mortgage has 0% risk, nobody can take away from you the fact that you have paid the mortgage off. Putting money in the bank is almost 0% risk as well, since the money is insured through deposit insurance (FDIC in the USA). Unfortunately, very few banks will offer savings accounts that give better interest than the home mortgage. This is logical, banks would lose money if they gave a better interest on deposits than what they take in on mortgages. (Putting aside some money in a savings account is a prudent and good idea for other reasons though, since it gives a cushion against emergencies where you don't need to borrow money.)

    Any other investment, such as stock market funds (stock prices may fall), corporate bonds (the corporation may default and go bankrupt), may have an expected rate of return in excess of the mortgage interest, but they also have risk of you losing the money. In the long run, this may makes sense, but you must be prepared to take the risk.

    ReplyDelete
    Replies
    1. 1. Paying off your home is anything but risk free. Flood, law suite and especially real estate market crash are very important risks. Think about someone that paid cash for a $500k house at the peak. They lost a very real $250k when their home value decreased by 50%. Someone that put 5%, 10%, or 20% down on the same house at the same time? They just have to walk away (not that I condone it), and the only thing they lose is the down and their good credit. Dave doesn't care about credit any way.
      2. If you had studied investment strategies like I (unlike Dave), there are many ways to safely and securely beat 3.5% interest on a mortgage. One example is certain types of options. Buy a long term option on the index. If the market goes up 10-20% you get a 10-20% return. If it doesn't you lose the cost of the option. Do this in the right entity/account and you can pull it out any time and pay off your mortgage.
      Again, I would never tell someone that paying off their mortgage is a bad idea, just that there could be a better use for their money. My biggest beef with Dave is that he is a "one size fits all" non-advisor. He is an entertainer and should be regarded as such. These financial decisions are very unique and personal. Something that is impossible for Dave to be due to his large audience.

      Delete

DISCLAIMER!!!!!!!!!!!!!! Financial Survivalist MAKES NO CLAIMS WHATSOEVER REGARDING PAST OR FUTURE PERFORMANCE of investments. ALL EXAMPLES, DIAGRAMS, DISCUSSIONS, LESSONS, OR RECOMMENDATIONS ARE FOR EDUCATIONAL OR ENTERTAINMENT PURPOSES ONLY. THIS BLOG DOES NOT AND IS NOT INTENDED TO PROVIDE FINANCIAL ADVICE OF ANY KIND. ANY COMMENTARY USED ON THIS PAGE IS FOR PURPOSES OF DISCUSSION ONLY. PLEASE SEEK PROFESSIONAL ADVICE BEFORE YOU TO BUY OR SELL SECURITIES AND YOU SHOULD NOT CONSTRUE ANYTHING ON THIS PAGE AS LEGAL, TAX, INVESTMENT, FINANCIAL OR ANY OTHER TYPE OF ADVICE. PROFESSIONAL ADVISE should be sought before entering any dangerous environment. Do not attempt any act described or discussed on this website.