Let me walk you though how coffee is negatively impacting on your mortgage.
Imagine you are on your way to work, and like millions of people around the world you decide you need a coffee to really kick start your day. Why not? There is no denying that its a great way to start the day.
It’s cold outside, and the coffee shop looks so enticing. You want to enter, and why wouldn’t you – this is your regular coffee shop and you follow this routine everyday you go to work.
Without hesitation you make your way into the line up for your regular morning coffee. At this point your brain starts to send out signals telling you that you need that cup of coffee. You start remembering how good it will feel to hold that disposable cup in your freezing hands and then carefully start sipping the contents, as your whole body starts to feel warm from the inside out.
The endorphins are well and truly starting to flow and you haven’t even ordered yet!
While standing in line, you look up at the exotic range of choices available. It’s now time to decide which particular blend you want to indulge in today. In the midst of your decision making a stranger taps you on the shoulder. He asks “Would you give up coffee for $100,000 or more?”.
At this point most people would have no idea what the stranger was on about, and likely respond with – “What’s this guy on?” or some other equally amusing yet dismissive quip. Sadly, only a handful of people will ever make the connection between unessential spending (in this case buying coffee) and the ability to use that money to pay off the mortgage at blistering speed with the added power of compound interest.
My coffee story
I had a similar encounter to that of the imaginary story above with my manager at work a couple of months ago. While the story is not exactly the same as it happened with us, it is close enough. In my world you can replace coffee shop with the work coffee cart and the tap on the shoulder with an early morning conversation around the confines of our designated work area.
When I discovered this coffee compulsion that my manager had, I was either being particularly astute or I possibly didn’t have enough work to do. I don’t know how or why I had begun to notice that my manager was bordering on being addicted to coffee. One day it just hit me that he was becoming a slave to his coffee routine. He would regularly wander over to the work coffee cart up to 3 times a day in search for his next coffee fix.
When I first approached him about the potential cost savings of dropping his coffee habit, he claimed that without the routine caffeine injection he would be a terrible boss who no one would ever want to work for. I personally wasn’t all that keen to find out if he was joking, but I felt that he deserved to see just how much money he could recoup if he was to reduce his reliance on coffee.
Working out the cost
I’m not sure if I have mentioned on this blog before or not, but I live in Australia and it just so happens that despite being “the lucky country” we are also terribly unlucky. I say this because if you ever visit, you will discover that everything is ridiculously expensive and that interest rates on mortgages are some of the highest in the developed world. At the time of writing this article the standard variable interest rate according to Australia’s biggest lender is 6.8% p.a.
Cost of coffee
I recently discovered that the average price of coffee is $3.47 (according to life hacker – What Your Daily Coffee Costs Around Australia). $3.47 doesn’t sound like much does it?
I don’t normally give much of a thought to coffee for $3.47 as when its purchased as a one off its hardly worth mentioning, but if you buy a few of these per day everyday of the week then things really start to add up.
In Australia the mainstream media like to spout all types of numbers and figures as fact and one of them is that the average mortgage in Australia is $350,000 on a 30 year mortgage. That’s a staggering $2,281.74 per month you will need to be making as a minimum repayment on your mortgage. That’s over $27,000 a year in after tax money straight back to the bank, while you barely put a dent into the principal amount of the mortgage. How depressing…
Before I can continue any further, I need to explain about compound interest.For those of you who don’t know what compound interest is I’ll give you a quick example which should clear things up.
If you had a bank account with a balance of $1,000 and an interest rate of 5% per annum which compounded yearly. At the end of the year (provided you were good and didn’t take any money out) your account would have $1,050 in it. The extra $50 you now have is interest that you earned over the year on your original $1,000 deposit.
Say you leave that money in the exact same bank account for another year, the starting balance would be $1,050. By the end of the second year, your bank balance would increase to $1,102.50.
This simple example is what compound interest is all about – earning interest on interest.
In the first year we only collected interest on the principal, which came to $50. In the second year we earned interest on both the principal amount and the interest accrued from the first year, which totalled $52.50.
Compound interest can add up very quickly, particularly when you regularly add additional money to the account.
Extra repayments on your mortgage
Continuing on from compound interest, is the benefits of adding extra repayments into your mortgage. For every extra repayment you make into your mortgage, you will have removed a portion of interest from your total debt – this extra contribution to your mortgage will compound for the rest of the life of that loan.
Let me repeat that – this extra contribution to your mortgage will compound for the rest of the life of that loan. So that means that the sooner you can put extra money into the mortgage, the more money you will save in the long term due to less interest accruing every year.
When you first add a couple of dollars of extra repayments into your mortgage, it might not seem like a lot of money. Particularly next to a giant mortgage loan of hundreds of thousands of dollars, but after a couple of years of continually adding a little bit of extra coin, you will really start to see a difference.
As an example – If I added $5 a week extra to my repayments for the average Australian mortgage (which was $350,000 at 6.8% over 30 years) I would save just over $10,000 worth of interest repayments over the life of that loan. This means I will be able to pay off the mortgage about 6 months early.
If there was no compound interest effect, then we would have only added an extra $7,800. Compound interest is able to save us an additional $2,200 over 30 years. Again, this might not sound like much but you have to remember that we are only talking about $5 a week – or about 1.5 coffees a week (my manager was having 15 coffees a week).
The effect of coffee on your mortgage
So, back to the original point of this post. Using the average coffee drinking Australian mortgage holder, we can assume the following:
- $350,000 of mortgage debt
- Mortgage interest rate of 6.8%
- A loan term of 30 years
- Coffee price of $3.47 per cup
- 3 cups of coffee a day
- 15 cups of coffee a week (Monday to Friday)
This works out to a cost of:
- $10.41 a day or $52.05 a week
If you were to add that $52 a week directly into the average Australian mortgage you would save:
- $127,049 worth of interest repayments on the life of the mortgage
- Amazingly, you also reduce the total mortgage time by 6 years and 11 months
Obviously the above example is simplified with a static interest rate and no mention of various bank fees and charges, but it gives you an idea of what is possible and how easy it is to cut back on something small and save bucket loads of money. Individually none of the coffee’s are all that expensive, however, I hope this has shown you how “relatively inexpensive” purchases have the power to add up to a sizable amount of money, particularly when that money is allowed to compound.
The final word
I have chosen to pick on coffee in this post due to my own experience with it and my manager, but do not think it is the only small purchase which is negatively impacting on your mortgage. There are plenty of life’s “little treats” which can be costing you years of time and hundreds of thousands of dollars in interest repayments you just don’t need to be paying.
- Chocolates / sweets
- Soft drinks / Flavoured milk drinks
- Chips / Crisps
and many more.
I highly recommend tracking your spending habits for a couple of months. This will allow you to gain an insight into exactly where you are leaking money, which in turn can be used to help you become debt free.
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