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The Power of Compound Interest

Writer's picture: Josh SurverJosh Surver

"Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it." - Albert Einstein


This isn't a complicated topic, but so many people don't apply this knowledge.


When buying a home, you not only have the opportunity to take advantage of compound interest... you have the opportunity to combine it with the cheapest leverage available - long term, fixed mortgages.


When you combine the power of a 0%-down loan program like the VA loan with a market-average real estate appreciation rate of 4% (https://fred.stlouisfed.org/series/ATNHPIUS17820Q) in my local market of Colorado Springs, you see an infinite return on your money.


Of course, reality is more complex. You have to factor in things like maintenance, capital expenditures (things like roofs, major mechanical system repairs, etc), insurance, taxes, and interest payments on the loan. And the denominator of this return equation, ROI=Return/Investment, is more substantial than $0 if you didn't receive any seller concessions (VA loans have a neat trick to put cash in your pocket rather than cost you something to close btw). But even after the complicated math, your return looks a heck of a lot better than renting.


Let's look at a wealth comparison between someone who bought a $300,000 home with a 30-year fixed rate 0%-down VA loan at today's average rate of 6.43% (https://www.mortgagenewsdaily.com/mortgage-rates/30-year-va) vs someone who rented.



The difference in your net worth is significant at the end of the year, with the homeowner being more than $12,000 richer. And that's just year 1. If you take a 4% average appreciation rate and a 3% inflation of expenses and rents, here's what you have in year 31 after the mortgage is paid off...



Your net wealth situation is now growing at $7,234.86/mo as you own the home free and clear, while our renter friend is losing $5,250.17/mo in rent. You also own a $1.012M home.


Many people don't realize that the $300/mo they're saving by renting at the beginning of the decision is really going to cost them millions in the end.


Wouldn't you rather collect interest in the form of appreciation on your home vs pay it to a landlord who increases your rents every year?


Please don't sacrifice your long-term finances for a couple hundred bucks per month less in housing payment now. It's not worth it. If you're in a position to buy, you should. And if you don't think you can buy because of one reason or another, consult a professional like yours truly... there may be ways to homeownership that you aren't aware of.

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