** Money Diary is about learning from fictional stories. If children can learn for tales and fables why can’t adults. This post will explore why your mortgage rates matter and how much of an impact they could have in your life. **
Let meet two friends Lester and Carl. They are both 25 years old and ready to purchase their first homes.
Lester purchases a $500,000 mortgage loan from Bank A for 30 years at 5.25% interest rate. His monthly payment, just the principal and interest, would be $2,700. Carl takes out a loan for the same amount for the same number of years but with 7.25% interest rate. His principal and interest payment would be $3,410. This is a difference of $710 per month.
Their difference is not just in the monthly payments. Lester with his lower rate of 5.25% will pay a total of $493,000 in interest only while Carl will pay $727,000. That is a big difference ! A whapping $234,000 difference.
Because Lester was financially savvy and understood how a loan calculator worked he put an extra $700 every year for the first 5 years and ultimately lowers the total interest payment to $379,000 and pays off his house in 25 years instead of 30.
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After 5 years Lester starts investing $700 a month in his retirement account in a total market index fund for 30 years. When he turns 60 he will have $1.6 million.
Lessons from this Mortgage rates matter story
- Don’t underestimate the impact of a 2% on a large loan
- The extra payments you pay towards principal in the beginning of a loan term will have a larger impact on the total interest paid.
- Paying off a mortgage alone does not guarantee a comfortable retirement. Focus on doing both in a more calculated way. Lester can pay an extra $700 per month every month until his loan is paid off but then he will not have the $1.6 million.
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