What Rate of Return is required in the side fund to pay off a 30 (or longer term) year mortgage in year 15 (or shorter term)? A key point is that due to the Tax Advantage of the 30-year mortgage, the side fund can earn a low rate of return and still pay off the balance of the 15-year mortgage at year 15. The terms of the mortgages (30 years and 15 years) will change depending on your inputs. For example, you can compare a ten-year and a five-year mortgage as well as a 30 and 15 year mortgage. |
Paying your house off in 15 years may not require you to have a 15-year note to do so. When you consider the tax benefits available in the 30-year loan option, the rate of return required on the difference between the two mortgage options may be well within your risk tolerance levels. |
The tax advantage in the side fund is calculated as the difference in tax savings of Mortgage One (the 30-year mortgage) minus the tax savings in Mortgage Two (the 15-year mortgage). After 15 years, the tax savings of the 15 year mortgage is zero. The required side fund rate of return is calculated using an iterative algorithm. Once it is determined, the solution is documented with the side fund worksheet. Documentation calculations are performed in a series of worksheets defined as follows: The first worksheet is simply the amortization schedule for the longer mortgage. The longer mortgage is the mortgage with the longer term, typically this will be 30 years but it may be any reasonable number. The second worksheet is simply the amortization schedule for the shorter/higher monthly payment mortgage. The shorter mortgage will typically be 15 years but it may be any reasonable number. The side fund worksheet includes two sources of funds. First, the difference of the monthly payment between the longer term mortgage and the shorter-term mortgage is treated as a deposit to the side fund. Second, the tax advantage of the longer-term mortgage over the shorter-term mortgage is treated as a deposit to the side fund. There are also difference in payments and tax savings worksheets. These simply isolate the difference between mortgage one and two for clarity. Side Fund Worksheet Column 1: Balance at beginning of month. Column 2: Monthly interest earned: (Column 1 * Investment ROR/12). Column 3: Monthly deposit of difference in payments (E.O.M.). Column 4: Monthly deposit of difference in tax savings (E.O.M.). Column 5: Account balance at the end of the month: (Column 1 + Column 2 + Column 3 + Column 4). |