Posts Tagged "loan payment"

Leverage Part 1: What is Leverage?

Posted by Preet on Aug 1, 2007 | 0 comments

Leverage: Think of it as using “other people’s money” to make money more quickly. Probably another topic that is best explained with an example.

Greg has $1,000 a year to invest for 10 years. Assuming a rate of return of 10%, at the end of 10 years he will have $17,531.

BUT, we know from the post on the magic of compound growth that TIME has a large effect on growth.  The philosophy is that if you could instead take all that $10,000 over 10 years and just put it in now, you will have more money than by putting it in over 10 years.

Okay, let’s look at a simple use of leverage: Greg only has $1,000/year, so he can afford a loan payment of $83.33/month (That’s $1,000 per year). First we have to figure out how much of a loan he can get. Assuming a 6% interest rate, $83.33/month for 120 months (10 years) will allow him to borrow $7,530.89. So he isn’t starting with $10,000 since we have to compare apples to apples (in the form of how much cash flow he is willing to dedicate to his investment savings).

Okay, so now let’s calculate how much $7,530.89 will grow to if invested and assuming the same 10% rate of return… My trusty financial calculator tells me $19,533. So in this case he has roughly $2,000 MORE through the leverage than with the yearly savings (which yielded him $17,531).

Now before you go out and get a loan to invest, remember that a lot of people get burned on leverages – as they magnify RISK as well as return. In Part II of “Leverage” I’m going to look at a negative scenario.

You know, the topic of leveraging is a big one – I envision that I could easily write a 10 part series of posts on it, and probably will. It’s glamorous, but please make sure to consult with a professional before getting one! This post is in no way meant to be taken as advice to get an investment loan.

Having said that, if you own a house and have a mortgage – you already have a leveraged investment! :) You have borrowed money to buy an appreciating asset.

Refinancing your home Part 2: An Example

Posted by Preet on Jul 27, 2007 | 2 comments

Okay let’s show how an actual couple ended up freeing $915.80/month by refinancing their home. I’ve rounded the numbers, but they are from a real life scenario. We’ll begin with a snapshot of what their financial situation was BEFORE:

Home Value: $250,000

Mortgage: $150,000 balance, 20 years left, 6% interest rate = $1,070 Monthly Payment

Credit Card Debt: $10,000 balance, 18.8% interest rate = $500 Monthly Payment

Vehicle Loan: $26,000 balance, 8% interest rate = $500 Monthly Payment

Department Store Charge Cards: $5,000 balance, 28.8% interest rate = $250 Monthly Payment

In this case, they have a total debt obligation of $191,000 and total monthly payments of $2,320.

By refinancing, they were able to take out $41,000 of equity from their house to pay out the vehicle loan, the credit cards and the department store charge cards. This increases the mortgage from $150,000 to $191,000. Plus, let’s add a $5,000 charge to break their existing mortgage for a total new mortgage balance of $196,000.

However, that entire amount is now being charged 6% interest and amortized over 20 years.  The new mortgage payment is $1,404.20. …but that’s the only payment.

So: Old Total Monthly Payment ($2,320.00) – New Total Monthly Payment ($1,404.20) =

$915.80 Saved Per Month

Take this with a grain of salt.  You have to factor in the trade-offs. Yes, you free up a lot of money monthly, but it has to be put to good and productive use. Also, before they would have freed up the $500 monthly vehicle loan payment in 4 years anyways, but now they blended it into a 20 year mortgage, effectively paying for that vehicle for 20 years. In many cases, these trade-offs are more than acceptable to people who are looking into refinancing as they are in dire need of a short term solution and even just a little breathing room is enough of a dangling carrot for them to proceed. In this particular case, a $915.80 monthly savings was very compelling and they are currently saving $700/month out of that into an investment account.