We’ve all heard the old adage that if you save $1 a day starting when you are 20, you’ll have more money than you need by the time you retire. This isn’t a miserly concept; it’s simply one of compounding: The snowball effect relates to the fact that what you are doing is not only earning interest on the money you put aside each month, but also on the accumulated interest from the previous month. That math builds and builds, growing in size like a snowball amassing fresh powder as it races down the hill.
In the housing market, there’s two factors we should take into account when analyzing how to take action. The first is: How effectively can we grow our funds? The second: How drastically will prices change?
Let’s tackle the funds question first. If $100K in real estate costs around $700 per month, what is better for your budget, a $700 per month higher payment or adding $100K to your down payment? In other words, can you save and accumulate funds more rapidly than it would cost to borrow that difference?
Your answer to this will determine if you should wait to, or simply, put more money down on your home purchase. If the extra funds toward your down payment are sitting in equity, it doesn’t mean that your property becomes more valuable. The market will dictate what someone will pay for your home (its value), not how much equity you have accumulated.
Perhaps you have other goals (say, putting kids through college) than simply purchasing a house. Could your funds not be compounding outside your home’s value instead? If you put that $100K in an average treasury bond, which yields at least around 3 percent, then in 10 years you would have close to $135K — even if you didn’t put an additional cent toward savings.
My favorite compound interest calculator can be found through the Compound Interest Calculator on Investor.gov. I like it because it is pure data — no pop-up ads, not owned by some company trying to sell you something. It is a great tool to showcase the power of saving. It can also outline how long your savings will last when you start to decumulate, a k a retire, yet the market still continues on.
Back to housing, we all know that home values rise and fall based on their previous level. A 5 percent change on a million-dollar property is $50,000. Assuming that appreciation happens every year, in 10 years, your property would be worth more than $1.628M. Considering prices have increased by more than 6 percent on average in the past 10 years, this is conservative for our local market.
Now, what would you rather have done: invested in a house sooner because you took on that $700 higher monthly payment or waited until you got another $100K to get a different down payment level? I cannot answer this for you, and I am certainly not telling anyone to over-leverage themselves (ugh, please don’t!). What I am reminding you is that money compounds. The snowball effect works the same way no matter the asset, yet the asset itself can dictate how large an avalanche occurs. By balancing math and emotion, we can be empowered to leverage toward a greater future than any old adage can align.
PS: Compounding can work for everything in your life, from habits to your mental state. Working out day after day builds muscle and stamina. Speak kindly to yourself more often and you will more easily shut down negative thoughts. By building on yesterday’s actions, your growth can catapult you past your wildest dreams. Try it! I believe in you.
Austin Lampson is a licensed mortgage professional and branch manager of Origin Point Mortgage. She has spent the last quarter-century helping her clients balance math and emotion to achieve their financial goals. Reach Austin at (805) 869-7100, austin@austinlampson.com, or visit austinlampson.com.
