Pay It Forward, Part 1

It is said that one of the biggest investments that most people have at retirement age is their house.  It usually takes families 30-40 years to pay off their mortgage so they own the house free and clear.  This debt often causes families to work at jobs that they don't like, it causes stress, and causes them to feel tied down. 

An alternative to this is for the family to live in a less expensive house and pay it off earlier (with the same monthly payment amount).  After it is paid off, they would continue to make the same payments, but into a savings vehicle.  This savings would build up much faster since the interest is working for them, instead of against them.  When the savings builds up to the value of a house, they would buy a second house, paying cash for it, and "rent to buy" it to one of their kids or to someone else who needs a break.  The rent would go 100% to principle and taxes, no interest or PMI.  They can pay it off early without penalty, or pay for it with the minimum monthly payments, and own it free and clear much earlier than with a conventional mortgage.  The buyers would agree to participating in the same program, where they would save the same payment amount until they can buy a second house and spread the love.  Meanwhile, the first family would be getting payments back for the second house and continuing to put payments into savings, so they could buy their third house before the second house is paid for by the renters.  Because of the margin created by living in a less expensive house and not paying interest, this program has the potential to increase in velocity and spread far and wide.  The risk is fairly low since all houses are owned outright as soon as the first house is paid for.

As an example, we could look at a house purchased for $200,000 paid for with a $6,000 down payment and a fixed rate of interest at 5%, with monthly payments of $1,041 plus PMI and taxes (total monthly payment of ~$1,260 for the first 10 years, when it will drop to ~$1,208).  Over the course of 30 years, the family will actually spend $391,757 on the house, and by that time it will be worth $485,452 if inflation stays steady at 3%.  The alternative example for this family would be to buy a house for $150,000 with the same $6,000 down and a fixed rate of interest of 5% on a 30 year mortgage.  The minimum payment would be $729.63, with an estimated PMI and taxes of $161 per month.  This family would pay the same they would have paid on the $200,000 house ($1,260/month).  PMI would go away in less than 4 years, and the house would actually be paid for in less than 15 years (with the same down payment and monthly payments!).  For the next 15 years, they continue to pay property taxes (which also increase with inflation) but would save the amount that they had been paying towards principle, interest and insurance ($1,093) into a savings vehicle with 6% interest. At this point (at year 30), they have $341,000 in savings, and can buy a second house of the same value (their current house is worth $367,000 at this point) and "rent-to-buy" that second house out for $2,200/month ($300 for taxes, $1,900 towards the principle).  Now their savings is increasing by an additional $1,900 per month from the payments coming in for the second house.  From a net worth perspective, the family has greater net worth in the alternative scenario starting at month 2 due to the amount of money they lose in interest and PMI in the first scenario.