Albert Einstein reportedly said “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
I talk a lot about earning compound interest. If you invest early and often, over long periods of time the wealth you can create is massive. But the flip side is also true. If you’re paying interest over long periods of time, the cost is enormous.
This chart hopefully illustrates that. When you take out a 30 year mortgage, even at a historically low rate of 4%, you end up paying almost as much in INTEREST to the bank as you do for the house itself! But if you cut the term in half, the payment doesn’t double. It only goes up by 54%. That’s because there’s way less interest being paid to the bank. More of your payment is going right to principal owed! Plus, you completely own the home with NO payment in half the time! If you put that mortgage payment toward investing the next 15 years, you’re rich!
Some may point out that mortgages are “cheap money”. If you can borrow at 4% and earn 10% with the money, you may be better off in the long run. But that trade involves risk. Because there’s no such thing as a guaranteed 10%. (These days there’s not even such thing as a guaranteed 2%). So instead of an optimistic 10%, if you get bad year like a -20% it could wipe you out. So be cautious about “over leveraging”. That’s where you borrow too much and put yourself at risk if the bad things happen. Personally, I’d never put less than 20% down on a primary home or less than 30% down on an investment property. On my own home I put down 100% and it’s nice to not have to worry about a bank hassling me.
As always, reminding you to build wealth by following the two PFC rules: 1.) Live below your means and 2.) Invest early and often.