Pay yourself first. That’s the wisdom from retirement planners who advise people to make their savings automatic, part of their regular budget, so they’re never tempted to frivolously spend the money they should be putting away. But with all our bills and obligation and the need to put food on the table, just how hard is that?
The answer may be “a lot easier than you think,” especially if owning a home is part of your plans. Your home can be a live-in savings account. Just like money in the bank, your home can be a financial asset. And just like the retirement planners recommend, that budgeted mortgage payment is building up your wealth a little bit each month, until a little turns into a lot. The way it works explains the key differences from a financial standpoint between renting and buying. When you make a monthly rent payment, 100 percent of that goes to the landlord, who pays whatever it costs to run his business and pockets the rest as profit.
A mortgage payment, however, is very different – and that difference makes you a little bit better off with every succeeding month. With a mortgage loan, you essentially rent money from the bank to buy your home. But every month, from your very first payment onward, a portion of your payment goes toward your ownership, or equity, in the house. It might seem small at first, but equity grows every month as the portion you pay in interest falls and the principal you pay off – the actual money that you borrowed – rises.
Take a 30-year mortgage loan of $200,000 at 4 percent interest – readily available today as interest rates have fallen to historic lows because of the poor economy. Your monthly payment of principal and interest is $954.83, a number that never changes throughout the life of the loan.
In the first month, your interest amounts to $666.67, while your principal payment is $288.16. By making that mortgage payment, you have bought equity – a financial asset just like a savings account – worth $288.16 in your home. You have increased your wealth by that amount. You own more tangible property. You have for all practical purposes saved $288.16 in an account that you and your family will live in and enjoy for many years to come. And the great thing is you’ll own more of that house every month as your payment includes more principal and less interest.
In the 13th month of the loan, you’re paying $299.90 in principal, and growing your equity by the same amount. In the 61st month – five years from your first payment – the principal is $351.85, and you’ve paid down nearly $20,000 of the loan.
If you’d been giving a landlord the same amount as your mortgage every month – unlikely, since rents go up and mortgage payments do not – you’d have nothing after five years. But you’re actually $20,000 richer because that’s how much equity you’ve bought in your house. It’s just as if you’ve saved $20,000, but you did so painlessly, as part of a monthly plan that puts money back in your pocket.
Sure, if you’d managed to put that money in the bank, you’d have earned a little interest, “a meager 0.13 percent” on average nationwide, according to a July 13 story in the New York Times. About $45 total.
Meanwhile, as the financial crash of 2008 fades, home prices are rising again in many parts of the country. It’s possible that the home you bought for $200,000 might be worth $210,000 or $220,000 five years from now if it’s value grew just one or two percent a year. As the owner, that gain is yours, not the bank’s or the landlord’s, and your wealth has increased by $30,000 or $40,000, not just the $20,000 you paid in principal.
We’ll have more on that in another column, but the message and math are clear. By buying a house, you are growing your wealth, every month and every year. And the story just gets better.