I met one of my clients for
beers coffee last week. During our conversation, we got to talking about the future and he shared that his youngest son would be out of high school in 6 years. Once his son was out of school, he wanted to travel more with his wife but didn’t think he would be able to because of the mortgage payment on his house. He had 15 years to go on his mortgage and is currently paying around $1,200 per month. His outstanding mortgage balance is around $113,000.
A quick online search to a loan amortization calculator showed he would have to pay approximately $1,800 each month to have his mortgage paid off in full in 6 years based on his existing terms. This new monthly payment is just a little over $600 more than he is currently paying each month. For him to pay off the mortgage with extra monthly payments, he would need to invest $43,200 over the next 6 years.
Since his main goal is to pay the mortgage off, I suggested a different approach designed to save him a significant amount of money while accomplishing the same goal. My suggestion was for him to buy two mobile home investments for cash and use the income from these two mobile homes to make the additional mortgage prepayments payments each month.
In most cases, an investor in my area can buy a mobile home which rents out for $300 a month for $8,000 to $10,000. Two mobile homes with these numbers would provide an extra $600 a month of income. He could use this investment income to make the monthly $600 mortgage prepayment.
The two families living in these two mobile homes will pay $7,200 a year towards his mortgage for the next 6 years. In total, these prepayments amount to the same $43,200 he would have to pay out of his pocket to pay the mortgage off early. By buying the two mobile homes instead, he would be saving $23,200 off his cost to prepay the mortgage. ($43,200 total prepayment cost – $20,000 he invested for the two mobile homes)
Plus, he would be eliminating $35,974 of interest by paying the mortgage off in 6 years vs. paying the mortgage off over the remaining 15 year term.
This one idea to buy two mobile homes for $20,000 could generate a total return of $59,174 in the next 6 years. This return is determined by adding the $23,200 saved through the mobile home investments to the $35,974 of interest saved by prepaying the mortgage. Based on an old calculator I have sitting on my desk, this return on investment is 195% in 6 years, for an average annual return of 32%.
Many people don’t think prepaying a mortgage is a good investment. They believe that the funds used to prepay the mortgage could be invested into better investment opportunities. This plan actually solves this challenge by inserting a higher return investment before the mortgage prepayment and this dramatically improves the total return on investment and helps him accomplish his goal with significantly less out of pocket.
Hopefully, you see this plan is the same idea I’ve written about before, which is to layer two investments on top of each other. So yes, this is another post on compounding.