U.S. CitiesCity-Data Forum Index
Go Back   City-Data Forum > General Forums > Economics > Personal Finance
 [Register]
Please register to participate in our discussions with 2 million other members - it's free and quick! Some forums can only be seen by registered members. After you create your account, you'll be able to customize options and access all our 15,000 new posts/day with fewer ads.
View detailed profile (Advanced) or search
site with Google Custom Search

Search Forums  (Advanced)
Reply Start New Thread
 
Old 01-15-2015, 04:09 PM
 
18,726 posts, read 13,505,396 times
Reputation: 14107

Advertisements

Quote:
Originally Posted by ncole1 View Post
The point is not to quibble over semantics, it is to use the correct numbers when making big financial decisions so that your answer tells you which option leaves you better in the long run.
With the exception of liquidity right? Which is the largest issue for most people and family budgets, thusly makes this entirely rediculous
Reply With Quote Quick reply to this message

 
Old 01-15-2015, 04:15 PM
 
12,673 posts, read 9,911,944 times
Reputation: 9451
Quote:
Originally Posted by TheOverdog View Post
Long term vs short term is a completely meaningless term with household consumption items like a mortgage or car loan. Your standard mortgage is 30 years, and car loans are up to 70 months. Is either of those not long enough?

You need to really refine your thinking here.
Most people don't live in one house for 30 years even if they have a 30-year mortgage.

The point remains that treating principal payment as an expense encourages people to stretch their loans out and think they suddenly made something affordable.

In the car case, if you compare the repairs or high gas bills on an old car to the monthly payment on a new one, you're either really tight on cash or you're a moron. The reason for this is that making a decision on payments means that it becomes more appealing and appears more cost-effective the more the loan is stretched out, which is of course not true and gets people into trouble when they are upside down because they stretched it out too long.

By considering the interest plus the depreciation as the cost (assuming negligible equity), you avoid these issues.
Reply With Quote Quick reply to this message
 
Old 01-15-2015, 04:20 PM
 
12,673 posts, read 9,911,944 times
Reputation: 9451
Quote:
Originally Posted by Lowexpectations View Post
With the exception of liquidity right? Which is the largest issue for most people and family budgets, thusly makes this entirely rediculous
Sad but true.
Reply With Quote Quick reply to this message
 
Old 01-15-2015, 06:07 PM
 
Location: Vallejo
13,997 posts, read 15,998,162 times
Reputation: 12610
Quote:
Originally Posted by ncole1 View Post
Most people don't live in one house for 30 years even if they have a 30-year mortgage.

The point remains that treating principal payment as an expense encourages people to stretch their loans out and think they suddenly made something affordable.

In the car case, if you compare the repairs or high gas bills on an old car to the monthly payment on a new one, you're either really tight on cash or you're a moron. The reason for this is that making a decision on payments means that it becomes more appealing and appears more cost-effective the more the loan is stretched out, which is of course not true and gets people into trouble when they are upside down because they stretched it out too long.

By considering the interest plus the depreciation as the cost (assuming negligible equity), you avoid these issues.
That's what stretching a loan out does, makes things more affordable.
Take a modest $200k house. For most people, it's not affordable as a cash deal. Now just making it a five-year mortage makes it affordable to some, but still not very many. By a 15-year mortgage it's affordable to quite a number of people. Extending out from 15 to 30 years does make it slightly more affordable, but really not that much more so. Extending from 30 years to 50 or more makes little difference in terms of affordability.
Reply With Quote Quick reply to this message
 
Old 01-16-2015, 10:15 AM
 
12,673 posts, read 9,911,944 times
Reputation: 9451
Quote:
Originally Posted by Malloric View Post
That's what stretching a loan out does, makes things more affordable.
Take a modest $200k house. For most people, it's not affordable as a cash deal. Now just making it a five-year mortage makes it affordable to some, but still not very many. By a 15-year mortgage it's affordable to quite a number of people. Extending out from 15 to 30 years does make it slightly more affordable, but really not that much more so. Extending from 30 years to 50 or more makes little difference in terms of affordability.
It depends on how long they stay in the house, on whether they are more constrained by current cash flow or by the need to accumulate wealth for the future, and on the interest rate differential between a 15-year fixed and a 30.
Reply With Quote Quick reply to this message
 
Old 01-16-2015, 10:27 AM
 
18,726 posts, read 13,505,396 times
Reputation: 14107
Quote:
Originally Posted by ncole1 View Post
It depends on how long they stay in the house, on whether they are more constrained by current cash flow or by the need to accumulate wealth for the future, and on the interest rate differential between a 15-year fixed and a 30.
The length you stay in the house doesn't make anything more affordable in cash flow terms up until the point the loan is paid off. Your first payment and second to last if not the last are the same.
Reply With Quote Quick reply to this message
 
Old 01-16-2015, 10:27 AM
 
Location: Vallejo
13,997 posts, read 15,998,162 times
Reputation: 12610
No, not really. Whether you stay in the house 1 day or 50 years doesn't make a difference. Due to transaction costs owning for very short periods is almost always not advantageous. It does depend on interest spread, part of why I said that there's not a huge difference between a 15-year and 30-year mortgage. Opportunity cost does increase the affordability of stretching, however, as most people willing to take some risk can earn better returns than a 30-year mortgage in the long run. Thus it's more affordable from both ends. Not only do the payments make it more affordable, but the time value of money put into investments further works in the favor of stretching the mortgage. The average 30-year mortgage is 3.66%. Tough to beat that, and that's before taking into account the taxshield. Yes, that is higher than a 15-year (3%) but not that significantly.
Reply With Quote Quick reply to this message
 
Old 01-16-2015, 11:17 AM
 
3,927 posts, read 4,013,016 times
Reputation: 4341
Quote:
if you compare the repairs or high gas bills on an old car to the monthly payment on a new one, you're either really tight on cash or you're a moron.
I still think you need to refine your thinking a lot. That seems like a huge strawman. Which repairs are you comparing? At what gas prices? These are variables, not full equations.

Quote:
which is of course not true and gets people into trouble when they are upside down because they stretched it out too long.
Stretching out loans does nothing to make people upside down. Asset price movements are irrelevant to current loan balance, assuming non-interest only. I could find a half dozen articles about businesses having liquidity issues, so having an army of accountants does not solve liquidity problems. In every one of the those cases, I'm pretty sure they are able to classify income vs expense correctly from an accounting perspective.
Reply With Quote Quick reply to this message
 
Old 01-16-2015, 11:25 AM
 
12,673 posts, read 9,911,944 times
Reputation: 9451
Quote:
Originally Posted by Malloric View Post
No, not really. Whether you stay in the house 1 day or 50 years doesn't make a difference. Due to transaction costs owning for very short periods is almost always not advantageous. It does depend on interest spread, part of why I said that there's not a huge difference between a 15-year and 30-year mortgage. Opportunity cost does increase the affordability of stretching, however, as most people willing to take some risk can earn better returns than a 30-year mortgage in the long run. Thus it's more affordable from both ends. Not only do the payments make it more affordable, but the time value of money put into investments further works in the favor of stretching the mortgage. The average 30-year mortgage is 3.66%. Tough to beat that, and that's before taking into account the taxshield. Yes, that is higher than a 15-year (3%) but not that significantly.
You need to remember that the opportunity cost of accumulated principal reduction is, of course, proportional to the cumulative principal payments. Let's consider a $175,000 fixed rate loan for illustration.

If you have a 30-year mortgage at 3.66%, the first payment includes a principal reduction of $267.79 and an interest payment of $533.75. For a 15-year mortgage at 3.0%, it is $771.02 to principal on the first payment, and $437.50 for interest.

Now between the first and second payments, the mortgagor has saved $96.25 on interest if using a 15-year instead of a 30. Even if we are generous and assume that the mortgagor's investment earns 12% annually, this is 1% per month. The first principal payment on the 15-year loan is higher than for the 30-year loan by $503.23 and thus the opportunity cost is just $5.03, which is far too little to wipe out the interest savings of $96.25.

The next month, the interest savings on the 15-year loan are going to be approximately the same since the balance hasn't changed much, but the opportunity cost will be roughly double, since the cost occurs on the first two principal payments.

Eventually you reach a cross-over point where the 30-year mortgagor begins to catch up with the 15-year mortgagor.

After 6 years, the 30-year mortgagor has an investment portfolio worth $40,049 if we assume 25% taxes on investment earnings*. The loan balance is $153,474.67. The difference is $113,415.67.

If we instead assumed a more modest 10% pre-tax return, the portfolio value would be $38,031 and the mortgage loan balance less this value is $115,716.67 as it turns out.

The 15-year mortgagor has no investment and a loan balance of $114,259.68 .

Thus, we see that for a 6-year holding period, you must be very aggressive in your assumption about investment performance in order to conclude that the 30-year mortgagor would come out ahead.

After 15 years at 10% gross rate of return, the 30-year mortgagor has $137,123 in investments and a loan balance of $110,899.19, while the 15-year mortgagor has no loan and no investments. Clearly the 30-year mortgagor is ahead after 15 years with 10% return, even though they were still behind 9 years previously.

So holding period DOES matter for long-term wealth as long as the cash flow is there to service either loan and invest any surplus.

*Assuming the difference in monthly payments between the 15 and 30 year loan is invested.

Last edited by ncole1; 01-16-2015 at 11:45 AM..
Reply With Quote Quick reply to this message
 
Old 01-16-2015, 11:26 AM
jw2
 
2,028 posts, read 2,620,877 times
Reputation: 3357
Another thread running amok.

I believe nclole's comment that a principal repayment is not an expense comes from this
Quote:
Originally Posted by Lovehound View Post
You don't understand. You are looking at the issue as a homeowner deducting your INTEREST. As a landlord you deduct the ENTIRE MORTGAGE PAYMENT, interest, principal, cat and kaboodle.

Get it? Capiche?
Full thread
Lovehound feels the entire payment is an expense. Well, not according to the IRS

In this context, ncole is right, the principal repayment is just a reduction of a liability. If you have a proper balance sheet, the principal repayment doesn't alter the net worth,, just moves it from one category to another.

I agree with ncole's statement because I think in terms of profit/loss and taxes.

However, the word 'expense' has different contexts, such as how much does something cost. I do not believe ncole meant it in this context
Reply With Quote Quick reply to this message
Please register to post and access all features of our very popular forum. It is free and quick. Over $68,000 in prizes has already been given out to active posters on our forum. Additional giveaways are planned.

Detailed information about all U.S. cities, counties, and zip codes on our site: City-data.com.


Reply
Please update this thread with any new information or opinions. This open thread is still read by thousands of people, so we encourage all additional points of view.

Quick Reply
Message:

Over $104,000 in prizes was already given out to active posters on our forum and additional giveaways are planned!

Go Back   City-Data Forum > General Forums > Economics > Personal Finance
Follow City-Data.com founder on our Forum or

All times are GMT -6.

2005-2019, Advameg, Inc. · Please obey Forum Rules · Terms of Use and Privacy Policy · Bug Bounty

City-Data.com - Archive 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20, 21, 22, 23, 24, 25, 26, 27, 28, 29, 30, 31, 32, 33, 34, 35 - Top