Hi everyone, this is Dan Thompson and welcome to another wise money tools video. We are talking about the 5 elements to wealth. And this time we're going to have a little bit of a crossover from our last video where we were talking about debt. In our last video, we were trying to determine good debt, bad debt, when to have debt, when to be using your money to build and grow. So this is kind of a crossover video. And I'm gonna talk a little bit more about what we had done in the previous video. But more specifically, we're gonna talk about paying off your home mortgage. Now, I'm gonna show you again, maybe some good debt, the power of compounding and time. So the question is, should you carry mortgage or should you pay off your house as fast as you can?

 

 

Now, I gotta say this because this is really important. Oftentimes, paying off a home is more of an emotional decision than a financial one. And I've never been one to try to talk someone out of paying off their mortgage, if they just feel like this is something they want to do. It's gonna give them all the peace of mind and safety and they sleep good at night. So that's great. And if that's you, awesome. However, in this video, we're gonna look at it purely financially, we're gonna take all the emotion out of it. And first of all, you got to realize one thing about home and especially home equity. Home Equity gets a 0% rate of return every day. We can month in forever and ever. Okay. Now, what do I mean by that? Well, we probably should describe what equity is. Equity is the amount of money you would literally put in your pocket if you sold your home.

 

 

It's the difference between what you owe and what you own. Okay, so if you have a home let's just say, it's worth or you could sell for $200,000. And you have a mortgage of $100,000. Well, basically you have $100,000 equity. It's the difference between your home's value or sales price and your loan balance. That 100k in equity, does not grow, does not get a rate of return and sits there idle everyday forever. But Dan, you say how can that be? My house is gonna be worth more in 10 years than it is today. And yes, that is true. However, think about this. If you have a home worth, let's say $200,000 today and in 10 years, it's gonna be worth $300,000. Now, it didn't matter if you owned your home by paying cash or if you had 100% mortgage. It really didn't. Your home went up value based on the market. Not how much money you put into it. So with or without a mortgage, your home went up from $200,000 to $300,000.

 

 

Now you certainly have to account for payments and interest and so forth. If you didn't own your home free and clear, but the equity in that home is always gonna get a 0% rate of return. So let's look at it this way. We're gonna take two couples, we're gonna call couple one, our accelerators because they're gonna go out and they're gonna accelerate their payments and pay that mortgage off as fast as they can. The other ones we're gonna call them mortgage yours, these guys are gonna keep their mortgage and they're gonna do other things with their money. So both start out with the same home, same down payment, same mortgage, same monthly payment. So each of them basically bought a $200,000 home, they put $40,000 down or 20% and they have $160,000 mortgage. Their payments are $1050 a month. Now, I'm not including property taxes and insurance. This is just pure principal and interest.

 

 

Now the accelerators, they heard the radio guy tell them that the paid off mortgage has replaced the BMW and so they want to pay off their mortgage as fast as they can. Now both couples have an extra thousand dollars a month for a total of $12,000 a year extra that they could put toward their mortgages. So the question is, would it be better to put that extra thousand dollars a month into the mortgage or somewhere else. So the accelerators by accelerating their payments, they're gonna pay off their home in 10 years and 3 months. So by adding that thousand dollars a month for the next 10 years. They're basically gonna pay their home off and own it free and clear in 123 months. Now once they pay that off they're really not gonna have any cash. They haven't saved, they don't have any other investments. They have all their equity in their home tied up in the sticks and stones.

 

 

Now at this point, they can finally start saving and investing because they've paid off their home. But they've missed out on 10 years, they're 10 years older, that means they have 10 fewer years to grow and compound their money. Now the other couple, the mortgagors, they decided to put their extra thousand dollars into a safe, accessible tax advantage location that averaged historically, about 7% in that same 10 years. Now, keep in mind that the Ramsey ites Davey says that after you get your house paid off, you can go buy mutual funds. And he says that they're gonna do 10 or 12%. But we're just gonna use 7% because no one's been able to figure What funds Dave buys? And we asked him all the time, Dave, please tell us which funds are you buying that are doing that. Anyway, at the end of 10 years, the mortgage yours are gonna have roughly $247,000 in their account.

 

 

Now, this is cash, they can access cash that they can use and turn into income at some point in the future as well. Now, how would the accelerators get their cash out of their house if they needed it? Well, there are two ways. They can either sell their house and take their money or they can get what's called a HELOC. A home equity line of credit. And as long as the bank's willing to lend the money, they could get some money out of their house because they put it all into the house. They don't have anywhere else to access capital, other than through a heat locker selling their home. How are they gonna generate income from there home, I guess they could Airbnb it on the weekends. But a home does not generate cash flow. Hopefully when or if they need to get some money, the bank will lend it to them. Or maybe the market will be at a really good time to sell and they'll be able to pull out some cash then.

 

 

Now remember, the mortgagors have the exact same home value, both homes went up at the same time at the same rate. So there was no difference in that. By the way, in year 10, they still have a balance of about $150,000 on their mortgage. And but they have $247,000 in cash. So the question is, could they pay off their mortgage now? Mortgage balance 150 they have $250,000 they could pay off their mortgage, couldn't they? And they would still have what $70,80,000 left over. But would that be a good idea? Would it be a good idea if they now took their money and paid off their mortgage. Well, our accelerators, as we've talked about have already paid off their mortgage. It's year 10. Again, they don't have any cash. It's all in their home. But now the accelerators can start saving $2000 a month, right? Because they don't have a mortgage and they had that extra $1000. So now they can start saving $2000 a month.

 

 

The mortgagors will keep on paying their thousand dollar mortgage and saving $1,000 in their side fund for the next 20 years. Okay, so it's been 30 years since they both moved into their houses. The mortgagors have finally paid off their home. All told over that 30 years, they paid $186,000 in interest. So for that home, they ended up paying $386,000 for their home. Oh, that sounds brutal, right? However, because they saved on the side and they compound in that fund. It has $2.4 million in cash. Now if we subtract the extra 186,000 they paid in interest, they still made over $2.2 million in cash. So can you see the power of compounding and time they use what I would call good debt into an asset a home that is appreciating. Now going back to our couple the accelerators, they were able to start saving $2,000 a month once they paid off their house. They use the same account that the mortgagors did.

 

 

But remember, they started 10 years later, because they were putting their extra money into their home. How did the last 20 years fair for them down the road? Well, their account grew to 1.4 million. That's not bad. The problem is they lost out on a million bucks by accelerating their house payments and paying off simple interest while they were missing out on compounding interest. And those 10 years made a huge difference. Now think about this, a million dollars at retirement can be a big difference in how you enjoy those retirement years. You can see how amazing really compounding is and why Einstein called it the eighth wonder of the world. You may have heard this little analogy before, but it's really incredible when you think of compounding. And that goes like this. I'm gonna give you two choices.

 

 

Okay, you can have $100,000 today right now, take it and run. Or you can have one penny today. And each day for the next 31 days. We're gonna double it. So in other words, you get a penny today. Tomorrow you get 2 pennies, then 4 pennies, 8 pennies, 16 pennies, 32 cents and so on. So which would you choose? 30 days of compounding or $100,000 today right now in your pocket. Well, you probably can't guess that this is a trick question and especially if you've heard it, because at day 31, a single penny would be worth over $10.7 million. And here's the schedule 1 to 2 to 4 to 8 to 16 to 32 to 64 to 128. And then it starts to get into some dollars we get here today 18 and now we've got $1,000 we finally broke the $1000 mark, then 2 then 5 then 10. By day 22 We have $20,000 by day 23 we have 41 then 83 and finally we get into where day 28 we break the million dollar mark. Day 29 2.6 million then to 5.3 million and finally day 31 $10.7 million.

 

 

Now that's compounding 31 periods. Now most people in their lifetime won't have 31 compounding periods of 100%. For instance, how long does it take for money to double at X%, you may have heard of the rule of 72. It's a formula that basically states that if you divide your rate of return into 72, that's how many years it takes to double your money. Now, it's not exactly accurate. But and especially as you get into higher rates of return, it even becomes less accurate. But it gives you a ballpark and it's easy to come close. So if I get 10% of my money and I divide that into 72, that basically says 7.2 years, I'm gonna double my money. Here's a table that's a tad more accurate, at 2%. And rule of 72 says 36 years, it actually takes 35. If we look at 12%, for instance, it says it's gonna take 6 years, it actually takes 6.12 and so on and so forth. Anyway, the idea is we want to find out how many times we can compound in our lifetime.

 

 

So it's not all that critical for this discussion if we're perfectly accurate. But what I want to point out is that over a working lifetime, we don't have many opportunities to get 100% compounding periods. Let's just say you start working at age 25, you basically have 40 years to grow your money unless you work past 65. But again, so let's use 10% average, which means we're gonna double our money about every 7 years. So if we divide 7 into 40, that means we're gonna have somewhere between 5 and 6 compounding periods in our lifetime. That's it. So even though it'd be nice to have 31 compounding periods and some very, very wealthy people might have a few of those. Then when we add in taxes, and costs and take away years of growth by losses. Well, I'm not trying to tell you all this to depress you. But what I want to point out is there are a couple of ways to put compounding in your favor.

 

 

One is the obvious one, start now start today. Don't let another day go by no matter how small the amount is to get compounding. The other way we can get compounding in our favor is to force accelerate the periods. Now if we go back and look at that 31 day compounding chart, but this time, let's assume that each day is 7 years, okay? If I already have $20,000 saved, I can force accelerate the process and I'm already at day 22. I find that lots of people have put money into mutual funds 401K's or other investments, and they also have some good income. We're They can start to save right away. If you can for start this concept with say $100,000. Now you're between days 24 and 25. Start with a million and bam, you're pushing day 28 already, where you get the idea. The more you can start with, the quicker you can bypass the compounding periods that seemed to be really slow grow for a while, I mean a penny to 2 pennies to 4 pennies to 8 pennies to 16 pennies.

 

 

I mean, you feel like you're getting nowhere right? Now, if you don't have the capacity, don't get discouraged. Just get started. You're gonna be surprised how much you can add to this over the years as your income grows. And then you can accelerate your compounding then I tell people all the time, you can't get back yesterday. So we've got to get started. Okay, I've got to wrap up this video because I don't want it to go too long. But we've got to touch on one other factor that goes hand in hand with compound, and it's not understood, and it's really not understood how devastating it can be to your compounding. So you've got to stay tuned for the next video or part two of compounding, if you will, because this is where we're gonna talk about that.

 

 

So make sure you subscribe. If you have any questions to him questions at wise money tools.com. Answer them just as quick as I can. If you want to spend a few minutes click on the time trade. We'll talk about your particular situation. In the meantime, we're talking about the 5 elements to wealth, and we're getting close to the fifth one and then we're gonna put this all together and wrap it all up in a nice package for you. So that's about it. Talk to you next time. Take care.