InvestorGeeks

What Gives With Interest Only Being Better Version 2?

by Christian

My original version of this blog entry has been deleted because I did find some errors in my spreadsheet. I saw them when I was explaining what I thought I had found while doing my calculations. The new calculations are not as I thought they were, but still some interesting things can be extracted from it.

I was reading a blog entry where one couple in Seattle had a hard time trying to find a place where they could take out a mortgage for 15 years. One woman in another blog commented that 15 years is a bad idea, and better would be a 30 year mortgage because it lets you buy more house.

Comments like, “ooh better get a 30 year mortgage than 15 year mortgage” raise my hackles! I don’t believe such comments and decided once and for all to figure out what the numbers are.

There are two variations to this scheme:

1) Get the same mortgage, but invest the monies

2) Get a bigger monies for the same amount that you would pay monthly.

Ok, so I created an Excel spreadsheet that anybody can download to verify if I am right or wrong. Folks, please verify my spreadsheet because I want to know if I accounted for everything, because I found out something very very interesting.

I made the following assumptions for variation 1:

• 300,000 mortgage
• 30 year mortgage at current rates (5.75%)
• 15 year mortgage at current rates (5.52%)
• Interest only mortgage at current rates (5.53%)
• Renting at 2,000 per month
• Income of 90,000 with tax rate of 25% with interest paid deducted from yearly income.
• 1.5% of 300,000 charge per year for maintenance, etc
• 9% return on alternative investments 
• 5% return on the price of housing
• The difference in monthly payments are invested into alternative funds

For variation 2 I made the following assumptions:

• 300,000 mortgage for the 15 years
• 530,000 mortgage for the interest only
• 420,000 mortgage for the 30 years
• 30 year mortgage at current rates (5.75%)
• 15 year mortgage at current rates (5.52%)
• Interest only mortgage at current rates (5.53%)
• Renting at 2,000 per month
• Income of 90,000 with tax rate of 25% with interest paid deducted from yearly income.
• 1.5% for yearly fees of the original price of the property.
• 9% return on alternative investments
• 5% return on the price of housing
• The difference in monthly payments are invested into alternative funds

Running the numbers I decided to sell after 10 years. At that time I decided that I would buy another house using the same prices.

Here is what I found for variation 1:

It does pay to get an interest only mortgage and invest the monies. At year 10 you pocket with the interest only 374,000, and the 15 year mortgage 323,000. This means you get 50,000 more by investing. However, this implies that you will invest the monies and get 9%. Granted both returns I searched and found on the Internet so they are averages over a time span of about 35 years.

If you only invested half the monies that the interest only gives you then you will be at a disadvantage. If you invest none of the monies then you will be at a massive disadvantage. In other words you will see the same amount less per month whether you use interest only or 15 year mortgage.

The tax advantage of the interest only vs the 15 year mortgage in year 10 is barely 200 USD, which in my opinion is nothing to write home about.

Here is what I found for variation 2:

Variation 1 was not what the original blogger was talking about. Variation 2 where you buy more house for your money was what the original blogger talked about. This means you would be investing nothing, and doing the numbers for this variation the results are not good.

Yes you can afford more house eg 530,000 vs 300,000, but after ten years it means you pocket less money 292,000 vs the 15 year mortgage 322,000. What I found particularly interesting about this variation is the associated risk. Your tax advantage in year 10 is greater (400 USD), but you have more costs since a more expensive house has higher taxes, etc. Additionally if you purchase a higher priced house there is a greater liklihood that you will not be able to sell your house.

Conclusion:

In my original blog entry, which I deleted, I said that the money you pocket is greater by paying off the mortgage. When I fixed my calculations for Variation 1 it was not the case, but it was the case for Variation 2. Though, what is extremely important to realize is that interest only or long term mortgages only apply if in the long term the markets and housing prices go up. If during the 10 year period you don’t get the required returns you are buggered. For example I did the calculations when both the investments and housing prices only increased by a mere 2% per year over a 10 year period. At that point the money that you pocket goes way up for the 15 year mortgage, and for the others you are left straddling quite a bit of debt.

So in the end it might cost more per month, but it is better to get a 15 year mortgage…

GM Buying Chrysler?

by Christian

There is a rumour going around that GM might be buying (2) Chrysler. The rumour was based on something things that Zetsche (CEO DaimlerChrysler) said:

Speculation about the future of Chrysler started earlier this week when DaimlerChrysler CEO Dieter Zetsche revealed the future of the money-losing Chrysler division was being studied, and that the company was open to all options. That could include a spin off, analysts say.

Analysts are saying that GM buying Chrysler is unlikely and more likely the hoopla is about a large SUV that both companies are looking into developing.

Here are the reasons why analysts are saying GM would not buy Chrysler.

The reasons GM would not buy Chrysler far outweigh reasons it would even entertain the notion. GM produces models in every major segment Chrysler does, so Chrysler’s lineup would be redundant. One exception: GM will soon stop making mini-vans, one of Chrysler’s strengths.
GM also has its hands full carving distinct identities for eight brands and keeping them stocked with fresh product. Buying Chrysler would add three more–Chrysler, Dodge and Jeep–plus thousands of dealerships at a time GM is trying to trim its sales network.

I disagree and Business Week has some more insight into this. Business Week is saying that GM does not want to loose the No 1 crown and will do whatever it takes. As per the article GM knows that Proton is a money loosing venture, but many want to remain No 1.

So here is the question; should GM buy another car company or not?

I think the answer lies in a move Carly Fiorina made at HP. When Carly bought Compaq many thought it was the absolute worst move that HP could make. Compaq had very few things that HP did not already do. Yet Carly went ahead anyways. This is very much a similar situation to GM and Chrysler.

Why did she merge Compaq with HP? Her answer at the time was necessity. She was of the opinion that one day the battle of Compaq and HP would be a distraction from the real battle that would face both Compaq and HP. I personally feel she understood globalization that sometimes I feel analysts dont. Sometimes analysts focus too much on a individual country.

I think GM understands that the global car industry is in a pickle. There is quite a bit of upheaval going on. Though you might think it is about Toyota, I say it is not about Toyota.

Do me a favor and think about the word Toyota for a moment. Keep those thoughts and think about Porsche. Were the thoughts identical? I doubt it. If somebody today gave you the choice of one car or the other without any strings attached, which would you choose? I am willing to bet it is the Porsche. BTW one little piece of trivia did you know that something in the order of 70% of all Porsches ever produced are still on the road (don’t know the exact number because I heard this stat a couple of years ago, but it was very high)? Tells you something of the love and loyality of a Porsche owner.

Everybody thinks Toyota is the big gorilla on the block and the car company to worry about. Toyota is the big gorrilla, but they are not the car company to worry about. Toyota is missing one element and that is loyality. Many of you are going to disagree that there are plenty of loyal Toyota buyers. No, what I am talking about is downright love-to-own loyality where even though you might drive X you wish you had Y. When I was a youngster (pre-teen days) love-to-own loyality was a Lamborghini, because at the time Lamborghini was featured in many TV shows, and movies. Of course it did not hurt that Farah Fawcette was stretched across the hood of one. (Male Chauvism emails directed at oops@tryingtomakeapoint.com)

Toyota does not have the love-to-own loyality that other brands have. Though they are trying with their new hybrid vehicles. Toyota is taking advantage of the current global warming trend and people across the world are saying, “oooh look how clean Toyota is.” EVEN though Toyota just introduced a monster pickup that pollutes with the best of them. The point is that Toyota is buying loyality, because I think Toyota knows as well there is a new threat on the block.

The new threat that both Toyota and GM see is China! Right now China is a non-issue. But wait in ten years. China will be able to deliver the quality at a fraction of the price. NOBODY on this planet will be able to compete against the Chinese automakers. The Chinese car makers do not have down to the love-to-own loyality, and thus if you buy a Chinese vehicle it will be for cost and quality. The Chinese car makers will eat Toyota’s lunch, and dinner, and breakfast!

All of the car companies will not be able to compete against the Chinese car companies using quality or price, and that is a major threat. Look at what the Chinese textile industry did to the local textile industry in any of the countries of this planet? Or how about electronic parts? The Chinese manufacturers take no prisoners.

So how do you compete against this threat? You can capitulate, but that is not an option for most managers. In the case of GM in two ways. Remove domestic competition like HP did, and buy something that people have love-to-own loyality to.

Chrysler is the perfect match to GM because of the following brands:

• Jeep has an extremely loyal base. There are people (like me) who will explicitly buy a Jeep because it is a Jeep. As GM already owns Hummer, buying Chrysler would give them a virtual lock-in to the real 4×4’s on the market.
• Viper which is one of the two ultimate American sports vehicles. Since GM owns the Corvette, owning the Viper would give them the two internationally accepted sports vehicles that are from America. NOTE: I once drove beside a Viper on the autobahn, WOW! I was doing about 140 MPH and it was well way faster than I. It seemed like I was standing still. The Viper and Corvette are accepted by German car enthusiasts as REAL sports cars.
• Mini-van which is a mainstay product for Chrysler. The Minivan is an accepted vehicle type by everybody throughout the world. And Chrysler is the champion of this vehicle type.

These three brands are known throughout the planet and accepted. Using these three brands GM could boost their own position. This is why I think GM does find Chrysler very interesting and I would not be surprised if GM were to take the plunge and buys Chrysler.

NOTE: So if Chrysler is so interesting why is DaimlerChrysler interested in dropping them? Using my arguments of the Chinese car maker threat Daimler wants to go back to what they do best; Mercedes and Mercedes Trucks.