Forced Savings

forced savingsYour bank may have a voluntary program where you can transfer $100 each month from checking to savings. After five years, you would have over $5,000 in your savings. You can view this as a type of forced savings.

The same happens when you buy a home with a standard amortizing mortgage. Each month as you make your payment, part of that payment is used to reduce the principal due on the loan. What is amazing is that over $4,000 would apply toward the principal in the first year of a $250,000 mortgage, assuming 4 percent for 30 years. At the end of five years, the mortgage amount would be reduced almost $25,000 through making normal monthly payments.

Also important to note is that while you are paying down your loan, your home is appreciating in value. The difference between the loan balance and the value creates your equity. If we can assume a 3% appreciation on a $250,000 home, its value over five years would increase by about $40,000.

Thus, a 30-year mortgage that began at $250,000 will be paid off in 30 years. If we carry that same three percent appreciation thru the term of the loan, your home would be worth around $600,000. But if you are renting, you are paying off your landlord’s home and not your own.

Now you can see how a lot of experts believe that a homeowner benefits from these forced savings when you buy a home. The tri-annual Consumer Finance Survey by the Federal Reserve Board has observed that a homeowner’s net worth is considerably higher than any renters.

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