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Would you pay $160,000 over sticker price on a home? Of course not, but millions of people do it all the time. In fact, it is common practice here in the U.S. We decided that we won’t ever finance another thing in life EVER. Why?
After recently becoming debt free, we obediently moved on to Baby Step #3, as Dave Ramsey recommends. Close to completing baby step 3, we found that we were somewhat unmotivated to save up more money. We were so traumatized by paying off all our debt, that we had begun to experience a little “frugal fatigue” and were just tired of saving.
Until we (re)discovered the time value of money, (yes, I’m an Econ major and should understand compound interest very well.) But honestly, it was all very “meh” to exert much more energy to save more money. However, there is something about bringing this stuff into real life that make you have to study and fully understand the power of your money. When it’s not tied up in frivolous consumerism or debt repayment, it can be very useful. More useful than you busting your tail at a 9 to 5 every day for 30 years. Money makes money. How profound! The opposite of that is paying interest. Interest eats money. How sad.
Yet, how many people pay $300,000+ for a house that should have cost a little under $170,000? If you are like most people who will buy a house, you will likely finance it. You will look through online listings, go through the mortgage pre-approval process and close on your very “own” piece of the American Dream and walk away from closing with a big fat monthly note.
We did this, too. Yes, the McClanahans. Though we didn’t borrow for a house, we did borrow for other, much dumber things. Ugghhhh! I could just punch something every time I think about the cars and other crap we financed before we knew anything about money. In some cases, we paid almost DOUBLE what the item was worth because of dumb, nasty, cruddy, sneaky, irritating, stupid INTEREST. The thought is enough to eat a box of Samoas in one sitting. I digress. Life must go on now that we know better.
Anyway, to prove the point I ran some numbers:
Say you want a house that costs $164,699. If you finance that amount over 30 years at a 5.25% interest rate you will end up paying $327,410.63 for that house! This is terrible, terrible news. Yet, if you save up $1,000 per month (about a mortgage payment on the same 30 year plan) for 10 years assuming an annual return of 6% on your savings, you would be able to buy that house outright for about $164,699! The difference is over $160,000! Why on earth would we ever put ourselves through 30 years of torture, when 10 years of savings can get much better results? Not to mention, what could you do with an extra $160,000 in your life?If we could teach every high school student in America this, there would be much less personal financial distress in our nation.
Before you finance anything else, run the numbers on the savings side and the borrowing side to see what you are sacrificing when you sign up for a note. If your plan is to become financially independent, then you have to go through this exercise. It could very much mean the difference between financial turmoil and financial freedom.
Weigh in! Could you delay your coveted home purchase another 10 years to save up for it and pay cash? If you are still unsure. Check out my post on Paying Cash for Big Ticket Items.