If you use the Loan Analysis calculator, you’re likely familiar with the “Loan View” provision. This enables you to do a side-by-side comparison of two loans, or view each loan individually. In the latest update of the Truth Concepts software, you’ll now see a third button: “Opportunity Cost.”
The function of this button is to more clearly show what Todd has demonstrated in his comparison of a 15-year vs. 30-year mortgage. That is, you cannot separate the analysis from the time value of money.
In previous demonstrations, Todd has used the Financial Calculators, such as Present Value and Future Value, to show that the opportunity cost of both mortgages is the same. In fact, the opportunity cost of a cash payment is also the same. You can see that in depth here.
The Cost of A Mortgage
In this example, say your client is shopping for a mortgage on a $250,000 house. His bank is offering the same 4.5% rate regardless of the amortization schedule. His 15-year mortgage payment would be $1,912.48 a month. For a 30-year mortgage he would pay 1,266.71 a month.
With Loan Analysis, you can input this information and compare the two. Then, by clicking “Cost Summary,” you can see the Net Cumulative Cost of each loan. From a pure cost perspective, the 30-year mortgage costs more. However, this is removed from the time value of money.
Solving for the Time Value of Money
This is where the Opportunity Cost button becomes truly fun. If you click on the button, it will look something like this:
If you’re thinking it looks like the same result, you’d be correct. In order to calculate for the time value of money, you must include the savings rate. Under both loans, adjust the savings rate to 4.5% for each, and you’ll see this:
By adding the savings rate, you’re effectively doing what the Future Value calculator accomplishes, by adding in the time value of money. In other words, what would the opportunity cost of this money be over 360 months at 4.5%?
Don’t Forget the Opportunity Cost of Cash
You may have noticed that when you toggle to “Opportunity Cost,” a CASH button appears. If you click that, you can calculate the opportunity cost of paying in cash. Input the same $250,000 and add a savings rate of 4.5%. This represents what that money could become at the same rate over 360 months. Here’s what you’ll see:
The result? The opportunity cost of each decision is the same. And if you plug this information into the Future Value Calculator the old-fashioned way, it will confirm.
What the Opportunity Cost Button Represents
Using the Future Value Calculators is a simple-to-follow method of showing your client why the Opportunity Cost of each option is the same. It shows the significance of the Time Value of Money, without getting too bogged down in the numbers.
The beauty of the button is how it shows the compounding effect of interest. In the column labelled “Compound Opportunity Cost @ 4.5%” what you’re really seeing is the potential interest earnings of each payment. And although the end result for each option is the same, the way the money compounds is much different.
The takeaway? The 30-year mortgage (Loan 2), has a much lower monthly opportunity cost. A lower monthly payment provides more flexibility and freedom, and free up more money for opportunities as they arise.
Get the Latest Update
If you attended November’s in-person Truth Training, this software update is available to you now. Otherwise, keep an eye on your email for more information about the latest software update.