Financial Limitations Corollary
March 25, 2008, 9:00 am
Filed under: Uncategorized | Tags: ,

Yesterday, I discussed my aghast reaction to an acquaintance choosing to purchase a house with no money down, and interest only for the first 10 years. My argument was that this was wasteful, because look at the long term cost of the loan.

However, I discussed this with my father. Generally speaking, my German family is very cheap and very financially savvy.  Perhaps I am young and naive, but I may have found a time when I disagree with him.

He defended the acquaintance, saying that depending on your tax bracket, having a long, big mortgage is beneficial. For instance, if you are in a mid-level tax bracket, but you work a lot of overtime (cops, social workers, blue collar workers, etc), that overtime (according to my father) is taxed not at the tax bracket your base salary is in, but at the highest possible tax bracket. By having deductions, such as children, mortgages and things like that, you can off-set those taxes. I disagree with this. The difference between the large, long mortgage and my preferred mortgage was about $70,000. I cannot believe that that mortgage will save you more than that in terms of taxes. Again, perhaps I am young and naive. Before I buy a house myself, I will have a discussion with a tax specialist to see what his opinion would be. Chances are, it won’t save me any money because neither Bear nor I will be working in jobs that involve a substantial amount of overtime, if any at all.

Therefore, if you’re just trying to lower your yearly taxes, but the cost of the loan per year is more than what you’ll be saving in tax deductions, won’t you be coming out behind in terms of total money?  I know that both I and my father are opposed to giving money to the gov’t. But if giving more to the gov’t and less to the bank means I have more in my pocket, THAT IS WHY I AM GOING TO DO.

There is also the opportunity cost. Whenever you buy anything, be it a latte or a house, you have lost the opportunity to spend that money on something else. If you buy a latte, now you’re 5 dollars poorer than you were before. If you only had $10 in the first place, now you have lost the opportunity to buy anything that is more than $5. So, if you have $20,000 sitting around, and you spend that on a down payment on a house, you have lost the opportunity to spend that money on something else. Like a new kitchen for your new house. Or a new car. Or something else fun like that. So, many people look at that opportunity cost and say that the down payment just isn’t worth it.

However, there is a hidden opportunity cost. This is an idea I have learned from Trent at http://www.thesimpledollar.com, and he was introduced to it by the book “Your Money or Your Life”. Every time you spend money, you lose the opportunity to use that money for something else. I just repeated myself, right? It goes further than that. You lose the opportunity to spend the money on YOUR LIFE. Something you truly want to do with yourself, not that temporary sugar and caffeine high from your latte. You lose the opportunity in another 20 years to retire early, and start a new career in something you truly love. Or, the opportunity to buy that dream vacation home in the Bahamas. Or, the opportunity to spend your retirement watching your grandbabies. Whatever it is that you truly wish you could do in your life, by spending your money unwisely today, you are paying the opportunity cost of those lost dreams.

I would argue that by not putting down that $20,000 on your mortgage and instead using it for a kitchen, you are paying the opportunity cost of reaching your genuine dreams. That cost comes in the form of the extra money you pay on your mortgage. Yes, you pay the opportunity cost initially by choosing down payment over kitchen. But, the secret opportunity cost is what you pay 30 years later when you don’t have that extra $70,000 in the bank, earning interest over those years, to fund your new business venture or space flight. It all comes down to the choices you make: what is it you want in life? The $20,000 kitchen, or the space flight? If the $20,000 kitchen is more important, then you ought to make that choice. But in the grand scheme of things, I would prefer the opportunity later in life to have an extra $70,000 to do with as I please, rather than paying a max amount of interest.

Another point my parents brought up was another possible choice. The acquaintance has a child, and is planning for more relatively soon. In fact, that is why they bought the new house: the old one could not possibly fit another baby. By paying 10 years of interest only, the acquaintance’s wife could stop working, or cut down to part time, in order to have more babies and get all of the children into grade school. If they didn’t do that, they might not be able to afford the loss of her salary. Since they need to have the babies now (biologically speaking) and not wait 30 years, it would make sense to do that.

As seemingly unrelated aside, I have a story. Last month, Bear and I  went to his home town for the weekend. His sister has identical twin boys, who are about 15 months old. They are adorable, but they are also rambunctious. We took them to the mall so that Bear could get his hair cut. His parents didn’t have the stroller with them that weekend, so we had to carry and/or attempt to restrain the boys so they wouldn’t run off. 15 month old little boys are resistant to holding hands, too. Independence and such. So, we had leashes for them. They were cute leashes: they look like a monkey is strapped to their banks, and then you use the tail to hold onto them. However, the tail is so low that if you pull too hard, you pull their feet out from under them. That’s mean, so we turned them upside down and had the tail on top, head on the bottom, so it looked like the monkey was sniffing their little butts. Awww. Generally speaking, the idea of putting children on leashes is a little disconcerting to me. They’re children, not dogs. However. When you are in a public place with two rambunctious toddlers who don’t respond well to verbal commands yet, and you want to avoid losing them, you have to put them on leashes. It’s one thing when you have one toddler, or when you have multiple children of various ages. But with twins? Good lord, the insanity! When we were putting them back in the monkey leashes after eating some lunch, I overheard a woman nearby say, “Oh, I hate when people put little kids in leashes. It’s just wrong.” VALUES JUDGMENT. Her values are such that putting a kid in a leash is wrong. Ok, fine. But I see you have two girls, about 5 years apart. It was probably fairly easy for you to wrangle the first one when she was this age. By the time the 2nd one was this age, the older one was around 7, and the younger one probably adored her, making it easy to have the older one help wrangle. Right? Not so with twins. Don’t judge, and keep your mouth shut. Plenty of people, Bear included, were put in leashes as children and they turned out fine. You know why? Because they didn’t get lost in a mall, abducted by a stranger, and then raped and murdered. You don’t know what it’s like with twin boys. I was a little pissed about that. I decided to try to avoid making values judgments about other people, especially out loud.

So, long story short, my parents reminded me without saying it that I don’t know the exact financial, tax and family situation in which these people are at the moment. Without being privy to their values and priorities, I don’t have any place in making judgments. Since I try to avoid values-based judgments (see above), I ought not judge them for choosing to spend more money in the long run on their mortgage. It is their money, they are free to do with it as they please. Knowing them, I am sure that they are not wasting it on booze and hookers, as my father so eloquently put it, nor are they racking up ridiculous credit card debt. Therefore, they are still making wise financial decisions, even if they are decisions I would not make.

But, I still hate interest, and I am going to sacrifice for 15 years in order to make sure that I can have my mortgage and student loans paid of ASAP. That’s important to me. I am willing to pay the opportunity cost of the nicer vacations, the bigger house and the luxury cars.

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