I have written numerous posts recently about the house we are buying. Last week I told a colleague about our mortgage: a 30 year fixed rate loan at 5%. My colleague's advice: "don't stop living". I asked him what he meant, and he explained that in the first few years of the loan, every dollar of principal you pay back, saves you about a dollar in interest payments over the life of the loan (depending on your interest rate and length of your loan). His advice: if you become hyper aware of this you will become overly conscious of your spending. Sure you would pay a dollar for a can of soda, but would you pay $2 for that same can? By buying that soda you are spending a dollar you could pay down on your mortgage and save an extra dollar in interest. You are in fact paying twice for that soda!
Yikes. I never thought of that.
There is a huge financial incentive to do the exact opposite of what my colleague advised. Do we really need those extra channels on cable if they are costing us twice as much? Do we really need to take that family vacation? How about that lunch out? But then, there is the issue of living life...
Interesting conundrum. Any advice or opinions?
5 comments:
His insight is a subset of a fundamental insight about money - every transaction has an opportunity cost.
The cost of a soda is twofold: the nominal cost of a dollar, and the opportunity cost of what that dollar could have provided otherwise. You could queue up some math here to determine the value of that dollar 20 years in the future had you chosen to invest it.
I still like your friend's argument though. I'd generalize it to the following: every time you consider a discretionary purchase, you should consider the other, more productive, things you could be doing with your money.
The trick is to find a healthy balance between deferred and instant gratification.
Yes - that's exactly right. It's all about opportunity cost. Only with mortgages, it's really easy to calculate the opportunity cost... :-(
But wait, maybe our house purchase won't come through after all. More details on that in a future post...
I'm biased on this topic, but still: I wouldn't recommend that you stop living entirely, but perhaps you could scale back your lifestyle a little bit and then reroute that money into the mortgage?
Is that "double" after accounting for inflation?
Frugal - moderation is always good advice... :-)
Anonymous - no, that's double in nominal terms. Of course, if inflation is taken into account, the real value is substantially lower.
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