Originally published in the News Star on Sunday, November 15, 2015
QUESTION: I’m thinking about buying some land. I could borrow the money to purchase it, but when I look at all those amortization tables it just kills me to see how much interest I would pay. I have enough in an investment account that hasn’t been doing much lately. If I use that to buy the land, I’ll save all that interest. Good idea?
ANSWER: Is it a good idea? I don’t know.
What I do know is that it’s a one dimensional idea, and that’s usually not good.
The problem is that you are only looking at one piece of your total picture. If you’re not careful you might find yourself bailing water out of the front of your row boat, only to pour it out into the back of your row boat (hint: not making any progress).
Let’s say you borrow $100,000 to buy a piece of land. If the bank agrees to finance that purchase for you at 4% over 20 years, you would owe the bank 240 payments of $606. If my $5 Wal-Mart calculator still works, that’s $145,435. That means you paid $45,435 in interest on top of the $100,000 worth of land you bought.
Well, gee, who wouldn’t want to save $45,435?
Hmmm…maybe the guy who sees the bigger picture.
Where did you say that $100,000 was going to come from? Oh that’s right, your investment account. Further, you said the account “hasn’t been doing much lately.” Fair enough. Do you know what your investments will do over the next 20 years? The answer is no, and neither do I.
For that matter, neither of us knows what the value of land will do over the next 20 years.
For the sake of an example, let’s suppose your investment account would earn 5% per year over the next 20 years.
If you kept the investment account intact, and bought the land with borrowed money (as described above), at the end of the 20 year period you would own the land, and your investment account would be worth about $270,000.
If you did as you are considering, and liquidated your investment account to buy the land, at the end of the 20 year period, you would have the land. Since you didn’t borrow any money, you theoretically could have use the $606 per month to put into the investment account you drained to buy the land. At the same 5% rate of return, if your kept up that $606 per month discipline every month for 20 years, you’d have almost the same $270,000 you’d have had keeping the investment account intact and paying the mortgage.
That’s how the math plays out. But guess how real life plays out?
My experience is that almost everyone would pay the $606 per month land note, as not doing so would result in foreclosure on the land.
On the other hand, having a voluntary plan to put $606 per month into an investment account is much more likely to be distracted.
Put another way, one method puts human nature on your side. Another pits you against it.
There is no single right answer to your question. We can work out the “right” way mathematically, while understanding that math is not real life. In real life, all sorts of things (good and bad) constantly compete for our dollars, wooing us away from fragile plans made one dimensionally.
Yes, consider the math. But at least as important is to consider the “me” factor. What are YOU most likely to really DO in the end?
That’s your answer.
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Byron R. Moore, CFP® is Managing Director / Planning Group of Argent Advisors, Inc. Email him at firstname.lastname@example.org. Write to him at 500 East Reynolds Drive, Ruston, LA 71270 or call him at (318) 251-5858. The opinions of any single advisor do not necessarily reflect the opinions of Argent Advisors, Inc. No forecasts can be guaranteed. Argent Advisors, Inc. does not offer tax, insurance or legal advice. The information contained in this column should not be construed as a substitute for personalized investment, tax, insurance or legal advice.