Monday, May 3, 2010

Immediately Pay Off Mortgage with Inheritance Money vs. Get Standard 30 Year Mortgage. Which Choice is Better?

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If you are buying a house off the proceeds of a large inheritance, should you immediately pay off your mortgage or should you just get a standard 30 year mortgage? The following story should help answer this question.

Twin brothers, Larry and Louie, both decide to purchase identical homes, with the same original mortgage amounts ($300,000.00), through the same mortgage company, on the same day. Their father had just passed away and they were able to split the $600,000 death benefit, from their dad’s life insurance policy.

Louie decides to take his half of death benefit and immediately pay off his new $300,000 mortgage. Louie was told that he would save over $347,000 in interest payments, would own his new home free and clear from day-one, and would never have to make a monthly mortgage payment.
Larry, on the other hand, took his half of the death benefit and put it in a diverse portfolio of growth mutual funds. He then withdrew $1,798.65 each month, for 30 years, to make the monthly Principle and Interest payment.

Who made the smarter financial choice – Larry or Louie?


Louie has his home paid off immediately, and never has to worry about a monthly mortgage payment. Also, because Louie has no mortgage, he saves $347,514.00 in interest payments over a 30 year period, as opposed to his brother Larry.


Larry had $1798.65 withdrawn from his mutual fund account (initially fueled with his portion of the inheritance) every month over 30 years to make his mortgage payments. Over that time Larry will have to pay $347,514.00 in interest. Also, it is interesting to note that Larry will still owe $213,146.93 on his home after paying for 15 years!


Well here is a fact that not too many people know: $300,000.00 only has to work at less than 2.58% over 30 years to generate $647,515.00 – the total cost of Larry’s mortgage including priciple and interest! With Larry’s portion of his inheritance sitting in a mutual fund making 12% interest, he will have accumulated $900,170.67 after 15 years and by the time he payed off the mortgage he will have accumulated $4,490,675.15. And this would all be possible while still withdrawaling $1798.65 a month and also by not having to deposit another single cent into the account!


In both examples, each brother had the immediate tax free use of $300,000.

Summary:
  • Both twins were given $300,000.00 Tax-Free.
  • Both bought identical homes, each with a $300,000.00 original mortgage.
  • On settlement day, Louie refused the original mortgage and traded his $300,000.00 for his “fully paid off” new home.
  • On the same settlement day, Larry accepted, and closed, on his standard 30 year mortgage, and then put his $300,000.00 to work!
  • Louie’s $300,000.00, invested immediately to pay off the mortgage, only works about less than 2.58% over the same 30 years! Louie invested $300,000 in bricks and mortar that can do virtually nothing financially meaningful. (All other things being equal, both homes will appreciate the same amount over the 30 years. Home appreciation is totally independent of whether the home is paid off, or has a mortgage attached to it.)
  • Larry’s $300,000.00, working at 12% in a portfolio of mutual funds, will provide a withdrawal of $1,798.65 each month for 30 years (360 months) – and still continue to grow to $4,490,675.00 by the end of the 30 years!
  • 30 years later, you can see what each twin has to show for their original gift of $300,000.00:
    • Louie has a home that he has owned for 30 years
    • Larry has a home plus several million dollars
The Money Message:
  • Don’t sell your “Money Machine” too cheaply!
  • Try to keep emotions out of financial decisions.
  • From a financial point of view, it is rarely ever the best to accelerate the payoff of a low interest rate mortgage!
I'm so excited to share this information with you. If you have enjoyed the information or feel that it would benefit someone else, please share it. If you have any questions or comments, please feel free to contact me.
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