What’s the major reason that people want to have their house paid off? In most cases, people fear a scenario where they can’t pay their mortgage, so they spend more money up front. Too often, this puts them in the scenario they were trying to avoid. It all comes down to control, and a 30-year mortgage simply gives you more control.
We’re going to run an experiment here, and see how you can actually save more money in your own pockets.
Setting Up in Loan Analysis
To begin, pull up your Loan Analysis calculator. We’ll input the following data into the calculator:
- Loan of $400,000
- Loan rate of 3%
- Loan period of 180 months (15 year) and 360 months (30 year)
What’s different from our usual setup is the Illustration Period. In the past, when we’ve compared mortgages, we compare them over the whole 30-year time frame. This time, because we’re refinancing the 30-year mortgage, we will only compare the loans over 10 years, or 120 months.
When the data is entered, your calculator should look like this:
You’ll see that after 10 years, the remaining balances are very different—this is a big reason people get scared of the 30-year mortgage.
However, if we truly want to compare, shouldn’t the homeowner be making the same payment regardless? Let’s just see what happens when they save the difference.
Analyzing the Loans with Equal Payments
First, copy the exact payment on the 15-year mortgage. Then, paste that value under Alternate Payback, by clicking the circle in the Monthly Payment row and then pasting in the box.
Under Loan View, toggle to Loan 2 only, where you’ll see the excess payments of $1,075.91 (i.e. the difference between the loan payments).
Rather than sending these excess payments to the mortgage company, however, we’re going to keep that in a separate account that the homeowner controls. While this money COULD be used to lower the debt, that strategy actually gives more control to the bank.
The Effect of Taxes on Mortgage
Next, let’s compare the effect of the tax deduction on the different mortgage payments. In a 24% tax bracket, you’ll see that the mortgage deduction is a little more than $20,000 cumulatively, for the first mortgage.
Add the same 24% tax bracket to the 30-year mortgage, and you’ll see that the tax savings are a little more than $25,000 cumulatively.
So what can you do with those tax savings? Potentially, earn a bit more on it by saving it. On the 15-year mortgage side, you can only save those tax deductions, while on the 30-year mortgage you can save the deductions and the excess payments.
Saving Money with Mortgages
On both sides, let’s add a 3% rate in the NET Savings Rate box, and go back to the comparison mode. Below, you’ll see that the savings on the 30-year side are much higher.
Ultimately, the question is—where do you want your money to be? In your pocket, where you can control it, or in your equity, where the bank controls it? While the loan balance may be smaller, the savings potential with a 30-year mortgage is much higher.
Keeping Track of Savings in Cash Flow
Now comes the fun part—the refinancing. Before we can do that, we have to keep track of the savings somewhere, and for that we will use the Cash Flow Calculator. When you open the calculator, you’ll want to illustrate over 30 years, and add a savings rate of 3%.
Next, you’ll copy the final savings value of the 15-year mortgage in Loan Analysis. Then, paste the value into year 11 under the Annual Cash Flow column. Finally, in the 12th year, you’ll zero out the column. Your calculator should look like this:
What we’re illustrating is the continued value of these savings over the 30 years, if they were to sit and keep accumulating at 3%.
In the next step, you’ll click the “New” button in the right-hand corner, and repeat these steps for the 30-year mortgage.
Refinancing the Mortgage
To simulate the refinancing, we’ll need to pull up a new Loan Analysis. Much of the setup will be the same, HOWEVER, there are a few key differences. First, we must pull the loan balance from the first illustration. You will do this by opening your FIRST Loan Analysis and changing the Illustration Period to 121 months. That’s because it shows the “Beginning of Month” balance.
Scroll to the bottom of the chart and copy the loan balance in the last box. Then, you can paste it into your new Loan Analysis, under Loan Balance. Then make sure you remove the negative sign.
The other key difference is that the loan period for the 15-year will only be 60 months, simulating the remaining 5 years. On the other hand, the 30-year Mortgage will start over again with another 360 months.
However, we will only illustrate over the next 5 years (60 months).
All other information and steps should be the same. Your Loan Analysis will look like this:
The refinancing has effectively reduced mortgage payments and increased the savings potential.
Now, you can continue tracking the savings in your Cash Flow calculator. You’ll want to copy your final value under the 15-year mortgage, and paste it into column 16, while zeroing out what’s beneath it. Under the 30-year, you’ll paste the final value into year 16, and zero out what’s below.
The Objectives of the Mortgage Demonstration
Ultimately, we’ll continue with these steps until we’ve fully illustrated the savings you can have with a 30-year mortgage (refinanced twice) and a 15-year mortgage. The results might not surprise you, however they may surprise your clients.
At this 3% rate, the homeowner is able to save over $500,000—which is more than their starting mortgage. This also means that in a lean year, or job uncertainty, they have money to pull from and still come out ahead.
Note: The savings reduces so dramatically after 15 years because the homeowner is no longer saving the difference of the 15-year mortgage. Though they could continue to save that amount in theory.
On the flip side, the homeowners have only saved $48,904 over the course of their mortgage, and have very little flexibility for making payments or paying off their home with their savings.
For Even More Insight, Check Out TC360
The above scenario is just one of the many special topics Todd covers in his monthly TC 360 in 60 trainings—which are only for software members. You can get the full story (and see exactly how Todd does the loan payments, plus other things not mentioned in this tutorial) when you sign up. You’ll have instant access to past recordings!
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