Tuesday, December 4, 2007

"The Automatic Millionaire" (Chapter Six)

Poor people rent, while rich people own their home. In fact,

According to one survey of consumer finance published by the Federal Reserve in January 2000, the average net worth of renters was $4,200 vs. $132,000 for homeowners. In other words, homeowners were more than 31 times richer than renters! (page 160)
No doubt you have been told that before. It is true, at least to a certain extent. Rich people aren't rich because they have a house payment for thirty years. They also didn't get rich with a massive mortgage on a huge house they really could not afford.

The next step in David Bach's plan is to automatically pay off your house. How do you do that? It's not as hard as it may sound, if you follow Bach's plan. There are really just two steps!

1. Buy a house, but buy a house you can afford. From pages 162-165, Bach lists 6 reasons to own a house. These six reasons are worth your time. Bach then takes the time to walk the reader through different kinds of loans and companies that can help you understand more about this massive purchase.

Also in this section, Bach discusses the question, "How much can I afford." While the numbers are a bit odd, he says that a person can afford to spend up to 29% of their income if they have debt (unless the debt is out of control), and up to 41% if there is no debt. Personally, I think both of these are a bit high. I am not comfortable paying more than 25% of my income for a house, because there will always be other costs!

Unlike Dave Ramsey, who recommends getting a 15-year fixed mortgage, Bach says it is okay to get a 30-year mortgage. BUT, only if...

2. Pay off the mortgage quickly and automatically. How do you accomplish that? There are three ways that Bach recommends, all of which equal about the same thing:

First, you can enroll in a bi-weekly payment plan. In other words, you will pay on your mortgage every two weeks instead of each month. How does that help? Run the math. There are 52 weeks in a year, so you make 26 payments. That equals thirteen months!

Second, if your company does not offer bi-weekly payment, you can just send in an extra payment at the end of the year, and ask the company to apply the entire payment to the principle amount of the mortgage.

Third, you can pay "extra" on your mortgage. If you do this, Bach recommends paying 10% extra each month.

No matter which of these you choose, Bach recommends you do them automatically if possible. Once you have paid a bit extra for 3 or 4 months, you will no longer "miss" the money.

Finally, how much of a difference does this make? A house, when purchased correctly, is a great investment, but keeping the mortgage for three decades greatly hinders that investment. Paying just a small bit extra can save you tens-of-thousands of dollars over time! By way of example, Bach uses a $250,000 mortgage. If you paid for 30 years at 8% you would pay $410,388.12 in interest alone! However, if you paid every 2 weeks and had the same terms on your mortgage (30 years at 8%), you would pay $119,000 LESS!

Owning a house, when you are financially ready, is a great decision, but having the mortgage around forever is a terrible idea. Follow these steps and you can greatly help yourself truly OWN your home more quickly.