Everyones life’s journey begins with going to a college, taking a loan, graduating and finally starting a dream job. After starting a job, many people live frugally and pay off their student loan while others paying bare minimum monthly payments. I started work, lived frugally and kept on paying my student loan. I finished and I felt great. Unfortunately, recently I realize this could be the first biggest mistake I made in my life that set me back by few years to become a millionaire
The next stage of life is to save enough down payment for house purchase and buy a house. The house will come with a loan
Covid Pandemic was a scariest time for all. Life threatening events and uncertainty in stock market. Just like everyone else I was working from home and lived frugally. Living frugally helped me saved good sum of money. Since there was uncertainty in the stock market I use the money and keep paying to my home loan that has 3.625% interest rate. This is the second biggest mistake
The last and final mistake is I repeated the mistake on my second home. The interest rate on this home is 8.12%. Now you may be thinking this is not a mistake. It seems logical and I would pay the high interest loan. We both are wrong on this. Paying 8.12% interest is not smart thing to do for long run.
Would you pay more towards 8.12% interest loan or instead invest?
If you answer invest, I must say you have a good reason to choose the option. You may know the reason why it’s a smart decision to invest instead of paying the loan. To all the readers who choose to pay more towards loan. Let me show you why it’s not a smart thing to do
Case: Paying off loan
Let’s take a hypothetical example of purchasing a home with $300k loan amount at 8.12% interest rate. By the end of pay off date you’d have paid total cost of loan about $801,519. Now that is a huge sum of money. You could feel better to pay it off sooner and take a sigh of relief. Paying off can give you peace of mind but losing an opportunity to becoming a millionaire
Below is a screenshot of an amortization schedule with hypothetical numbers
Invest: $1000 every month
Let’s say you live frugally and you save over $1000 per month. Instead of paying it towards the loan. Let’s invest in S&P 500 index fund. Historically, S&P 500 fund has a return rate of 10% annually. Using this numbers we are going to run a compound interest calculator and compare it with loan final pay off amount. We will start with $5000 as a starting investment. Numbers are clear from pictures below.
What would you do now, Invest or pay loan?
To summarize, investing money will give you over $2 Million compared to $800K loan payment. Now we are all logical, you could think that what if S&P 500 returns only 5%? At 5%, we will break even with loan at 8.12% interest rate.
Use the amortization calculator on Bankrate and Compound Interest calculator to run through the numbers.
I hope you learned something new today