All Forum Posts by: David Collins

John, there are various factors to consider (get a better rate on the 15, e.g.?), but holding all other factors constant for a moment, think "opportunity rate"--what's the best return you could get with any 'extra' dollars you have each month by going with the 30 instead of the 15?

Suppose I have a note that I could amortize over either 15y or 30y, and its rate is 7% either way. By going 30, my payment is $250 less. Well, if I can put that $250 to work at, say, a 9% return, I'm better off with the 30y amortization. Sure, I pay a lot more interest by the end of the note, but the build-up of my 9% money more than makes up for it.

On the other hand, if the best I could do is earn 5% on any 'spare' cash, I'm better off using that 'spare' cash to paydown the 7% note--in other words, pay it off in 15.

Hope this helps, and good luck!

A pleasure, Mr. Santiago...

and just to wrap up, that 2K down payment (I assume you mean you received the 2K in addition to the note?) is just an adjustment to your "Transaction One", as I called it. The simple revision is that you bought for 45K and sold for 60.4K. Your ROR is calculated from the spread between those two, and the length of time it took to achieve that appreciation.

Your ROR on your investment in the Note remains unaffected at 8%. And as you say, this is all expressed in 'pre-tax' terms; the after-tax ROR would necessarily be less.

Take care,

Congrats on the profitable sale, Carlos!

It's almost always more informative and meaningful to separate "rate of return" analyses into the component parts of the situation. In your case, you've executed two transactions, each of which has its own ROR.

(All of the following is pre-tax calcs, of course.) Transaction One: You bought for 45K and sold for 58.4K. Your ROR on that move depends, of course, on the time interval between these two, but simplistically, it's what's called the geometric mean of those two values. For example, if the sale came exactly three years after the acquisition, your annualized ROR was 9.077%, compounded annually. This is your yield for the 'holding period' of the property.

Transaction Two was your decision to "reloan" or "invest" the 58.4K sale proceeds into an IOU. For this investment, your yield--or ROR--is precisely 8%, as indicated by the note's rate.

I've taken a very important liberty by ignoring risk for the moment. A correct ROR assessment should take into account the possibility of default on the note, and any expectations thereof. But I think that goes a bit beyond what you're looking for here.

I hope this helps, and best of luck!

Greetings, KB...best of luck in your investing activity!

It might help to keep in mind a simple fact: Mathematically, paying down a loan which bears interest at X% is identical, in terms of net economic value, to investing that same amount at X%.

Putting it another way, if you have Y dollars available to employ somewhere, just think of 'loan paydowns' as one more investment possibility, among your other options.

Suppose, for example, you could either use your discretionary Y dollars to pay down a 6% loan, or could instead deploy the Y dollars into an 8% investment. Paying down the loan is economically equivalent to investing at 6%, making it (obviously) the inferior choice in this particular fact set.

Without a doubt, you MUST also evaluate other factors. You might, for example, want to de-leverage your personal balance sheet for other reasons (risk; too much leverage; anticipated future financing), and this might override the simple "rate of return" rule of thumb I've described.

Nevertheless, it's a simple, and usually valuable, rule of thumb when evaluating your options.

Cheers!

...it was early and I was full of no coffee...

Late to the party as usual, but my two cents:

If the only question is whether or not to go with the no-down or the down-payment version, just consider the down payment question as a 'side bet'. The return on the property is what it is, regardless of how it's financed--the financing angles either add or erode value themselves, of course, but it's helpful to analyze them separately.

Adam's question thus boils down to: Good idea to pay $20K in order to get an extra $131 per month for 30 years? Running the numbers on this 'side investment' shows that it produces a pre-tax return of precisely 7%. No surprise there--paying down 7% debt is exactly equivalent to earning a 7% return on those same dollars.

Cheers, all, and best of luck!

...it was early and I was full of no coffee...