Financial Limitations
March 24, 2008, 1:41 pm
Filed under: daily | Tags: ,

I am German. That could mean a number of things to you:

1. That I must be a Nazi. HA! Funny story! My Grandma’s family came from the part of Germany that Hitler was from (Bavaria). Not only that, but they were from the next little village over from his. So, because of that, Grandma regularly tells me that we’re related to Hitler*, because “you know, all those people inter-bred and everything. But shh! Don’t tell anyone! They might be disturbed by it.” She usually tells me this in a public place. With other people around. Loudly enough for them to hear. “Hokay, Grandma! Won’t tell anyone!” Of course, if you use that logic, then everyone in Europe is related to Hitler. Going further back, we’re ALL related to Hitler, because we’re all humans! Whoa! No, we are NOT related to Hitler. Or the pope.

2. That my family collects large quantities of clock and beersteins. No, Emily, that’s just what YOUR Germans do.

3. That my family is painfully cheap, to a fault. Ding ding ding! We have a winner! My grandfather was convinced that he could get a better deal on furniture if he didn’t buy anything that matched. Brown and orange sofa with a red plaid chair? They MUST give you a deal because you have such terrible taste! We never followed that logic. Nor did he ever get a good deal on it. THAT’S HOW STINGY WE ARE. Anything to save a buck.

With that in mind, spending money gives me a stomachache. Spending large quantities of money makes me ill. Debt makes me pass out. I hate the idea of buying money. That’s what debt is. Somebody gives you money, and you pay for it. You don’t just pay them back, you give them EXTRA money for giving you the money in the first place. So, if you’re buying money you don’t need (for instance, going into large amounts of credit card debt to support your latte habit), you’re being exceptionally wasteful.

Now, I do believe that certain amount of debt is good. Student loans, for instance. It’s financing your future. Low rates, blah blah. Without that money, you can’t go to college (or whatever higher ed you want), and without that degree, you have an extremely limited earning potential. Student loans are an investment in your future. Totally worth it.

Mortgages are the same thing. As long as you don’t get caught up in the tail end of a bubble (and bubbles ALWAYS burst), your property will increase in value over the long haul. Financing that with a mortgage, and you will have a nice amount of change AND a roof over your head AND a warm place to pee. An investment in your future. Totally worth it.

However, that doesn’t mean you should pay more for it than you need to. I had a conversation with someone over the weekend who recently bought a house. A lovely house. Beautiful house. Great place to have a family. Et cetera. However, he told me in no uncertain terms that he does not believe in putting any money down for anything that he finances. That it is a waste of money, because you throw away your money and then never see it again. I was aghast. Uh. Gassed. I had to bite my tongue to keep my jaw from hitting the floor, because that is the exact opposite of good finances. He has the money to put down a down payment. But instead of doing that, he’s spending it to BUY the x amount of money to pay for the house.

Aghast!

Let’s do some math! Say you want to buy a house. The asking price is $100,000. You get a 30 year, fixed rate (5%) mortgage on the house. That means that the bank gives you $100,000 for the house. You are now $100,000 in the hole. The cost of that money comes in the form of interest, which is 5%. The monthly payment is found by this formula, as given to me by wikipedia.org

c = (r / (1 − (1 + r) − N))P

c stands for monthly payment. r is the monthly interest rate, as expressed by percentage/100/12 months (5/100/12= 0.24). N is the period of time in months (360). P is the amount borrowed (100,000).

So, your monthly payment would be (0.24/(1- (1+ 0.24)^-360)) x 100,000, which equals, as calculated by Coldwell Banker’s mortgage calculator, $536.

Now, if you multiply that by 360 (the number of times you will write out that check over 30 years), you get: $192,960. What is that number? That is the total cost of the loan. You are borrowing $100,000, and they charged you $92,960 for it. Just think about that for a little. You spent $92,960 to buy $100,000. You nearly doubled the price of the house. Nauseating, isn’t it?

However, if you pay a down payment, your cost will go down. What is a down payment? Essentially, you are paying for a portion of the cost of the house, and taking a loan out for the remainder. A recommended percentage is 20% of the price. So, if you want to buy a $100,000 house, you ought to put down $20,000. That’s a lot of money, no? Of course it is! However, look at what it saves you. Instead of buying $100,000, you are only buying $80,000. Plug in those numbers, and you’ll be paying $429 a month. That’s only a savings of $107/month. That doesn’t seem worth it, does it? Doling out $20,000 bucks in order to save $100? True. I will grant that there is sticker shock there.

However, multiply that times 360. You get $154,440. That is the total cost of the loan. You are still paying a lot of extra money, still. However, by spending that $20,000, you just saved yourself $38,520 between the two loans. Overall, the difference in cost is $18,520. The more money you put down initially, the more you save.

You can also save money by decreasing the length of the loan. By speeding up the rate you pay, you obviously increase your monthly payments. However, since the interest is charged per month of the loan, the shorter the period is, the less interest is charged, making the loan cheaper.

The same loan ($100,000) over 15 years rather than 30 costs $729 a month. That is almost a $200 difference per month, which might seem hard to swallow. However, over the course of 180 months, you will pay $131,220. And that’s without a down payment. With a 20% down payment, your monthly payments would be $632. The cost of the loan will be $113,760.

Now. Look at those numbers. The first number, $192,960 is with the acquaintance’s theory (no down payment because you never see the money again, long loan period). The last number with my theory (at least 20% down payment, short loan period) is $113,760. That is a huge difference. Essentially, if you choose to have $20,000 in your pocket at the beginning of the loan, and a few hundred dollars extra a month, you are paying for that luxury with $79,200.

So tell me how a down payment is money that is taken from you, never to be seen again? Maybe it’s just my German stinginess coming out, but I think that that’s actually the definition of INTEREST.

*Funny enough, the new pope, Benedict, was also from that general vicinity. People made the same conclusions about him. He’s from Bavaria! He must be related to Hitler! Pope Hitler! However, when I pointed out that Benedict was from there, and there was a good chance that he was related to us (my dad maintains that he’s the spitting image of HIS grandfather), she said, “Oh, Katie. Don’t be silly. We’re not related to the POPE!”

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