Residential Home

Home Example

Let's say you're buying a home and financing $100,000 @ 5% over 30 years. In this scenario you will pay ~$94k in interest. So you pay about double for the home ($200k) over 30 years.

If you were to go the cash route you would be out $100k (maybe less if you knock the price down by paying all cash) but you would pay $100k for the home over 30 years.

The question becomes the velocity of money. How good are you at getting your money back? How important is it to have your money paying you off your own investments vs just sitting in savings or a liability like a home?

Most people don't think about the kind of stuff I'm talking about so allow me to explain. Most people don't really invest their money. Most people leave their money in a bank or CD or bond or something that pays like 1% or 2% a year. So taking our example from above, with $100k at 1% interest over 30 years you will make ~$35k and turn your $100k into $135k. At 2% interest you will turn $100k into $181k over 30 years. Okay, so in both of these cases you come out under $194k after 30 years. Remember, the $194k is the total amount you would pay on your home after 30 years with interest. In this case it would be better for you to simply pay cash for your home simply because you can't outpace your home interest rate with your own money investment. Your 1 or 2% a year doesn't cover the costs on the interest you are paying on your home loan.

But what if you could make 10% a year on your money? What if you were a bit better with your money and were able to average about 10% a year? Now what is the better thing to do with your $100k? Should you plop it down on a home and call it a day or should you finance a home and use your money to make more money? The answer is obvious. 10% a year on $100k over 30 years is $1.7 million. So in this case, using the same home example numbers as above, you will easily be able to clear the interest paid on your home loan. Your home loan comes to $194k over 30 years. But you have turned $100k into $1.7 million by not paying for the home cash, and instead investing it at a decent rate. In this case, you were way better off not tying up your money in the home and instead investing it with a rate that outpaces your home interest rate.

Car Example

Let's do another example. Say you're buying a car and financing $100,000 @ 10% over 6 years. The same exact principle as above applies. You are looking at the velocity of money. On this example you would pay $34k in interest over 6 years, or $134k total over 6 years. The question becomes: can you make more than $34k on $100k over 6 years? If you are a decent investor and can pull say 10% a year then the answer is clearly yes. If you pulled 10% a year on your money you would have $177k after 6 years. That is $43k more ($177k - $134k) than you would have if you had paid cash and not made money off your own money to outpace it.

Conclusion

So what I'm saying is how important it is to use your money to make money. Investing is one of the smartest things to do. And in most cases your money should be tied up as much as possible getting you the highest return possible at the fastest speed possible. This is what is called the velocity of money and it is key to being a good investor. Better investments pay higher quicker. It is up to you to do the numbers and see what makes the most sense. Is it worth tying up $100k in a liability or should you just finance the liability with interest and outpace the interest on the liability anyway? But the conventional wisdom of buying everything cash, while fairly secure, may not be the most financially intelligent thing to do. It just depends.

 Filed under: Business, Real Estate, Finance, Loans, Investing

About The Author

Quinton Figueroa

Quinton Figueroa

Facebook @slayerment YouTube

El Paso, Texas

I am an entrepreneur at heart. Throughout my whole life I have enjoyed building real businesses by solving real problems. Business is life itself. My goal with businesses is to help move the human ...

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2 Comments

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Liz: Liability Interest or Asset Interest is up to You

However, it will always depend on the person which will he pay attention to. Either the liability interest or the asset interest, they are unique in their own labels and is helpful to those who really need them. Let us say that you as person who need them need to be wise enough to pick the right option that you need most.

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