(Business Insider) -- One of the most common decisions people make when buying a home can also prevent them from building wealth.
"If you want to know why most people don't become millionaires, look no further than the 30-year mortgage," wrote Chris Hogan in his book "Everyday Millionaires: How Ordinary People Built Extraordinary Wealth — and How You Can Too." In partnership with the Dave Ramsey research team, he studied 10,000 American millionaires (defined as those with a net worth of at least $1 million) for seven months.
"People throw away tens — even hundreds — of thousands of dollars on these loans without ever stopping to do the math," Hogan wrote.According to Freddie Mac, about 90% of US homebuyers opt for a 30-year mortgage.
Of course there are a host of other factors, like income level and spending patterns, contributing to someone's ability to become a millionaire, but according to Hogan's research, the average millionaire paid off their house in 11 years and 67% live in homes with paid-off mortgages. This puts their home entirely in the asset column of their net worth and wipes their biggest debt off the liability column, he said.
"On average, one-third of a millionaire's net worth comes from their primary residence," he wrote. "So, if you're sitting in a paid-for $350,000 home, that entire $350,000 counts toward your net worth. If you've got that plus $650,000 in retirement accounts, you're a millionaire!"
Hogan calculated the difference between a 30-year mortgage and a 15-year mortgage of $225,000.
For a $225,000, 30-year mortgage with a 4% fixed interest rate:
- The monthly payment (principal and interest) is $1,074.
- After 10 years, you would have paid $128,880 with a remaining principal balance of $177,264.
- The interest paid at this point is $81,000 — and you still have 20 years to go.
- After 30 years, the total interest paid would be $161,640.
For a $225,000, 15-year mortgage with 4% fixed interest rate:
- A monthly payment (principal and interest) is $1,664 — $590 more a month than the 30-year rate mortgage.
- But after 10 years, you would have paid $199,680 with a remaining principal balance of $90,369.
- The interest paid at this point is $65,049 — and you only have five years left.
- After 15 years, the total interest paid is $74,520 — about $87,000 less than the 30-year loan.
Not only would you pay less interest in the latter scenario, but you would have paid off almost twice as much of the principal balance after 10 years. Further, the difference in interest paid could have been put toward your net worth or into investments, Hogan said.
"Going against the flow and choosing a 15-year loan would have saved you more than $87,000 and would have put you in a paid-for home in half the time," he wrote. However, that's if you can afford it — 30-year, fixed-rate mortgages are especially appealing to homebuyers because of the comparatively low monthly payment,according to Freddie Mac.
To pay off a mortgage early, live in a home you can easily afford and pay extra each month
If you want to strategize like a millionaire and pay off your home in less than 15 years, consider Hogan's Purchase Price Paydown method:
Assume you have a mortgage of $250,000. Use the first three numbers of the purchase price — 2-5-0 — to make an extra monthly payment. In this case, it should be $250.
If you pay that much extra every month, you'll pay off a 30-year mortgage 8 1/2 years faster. On a 15-year mortgage, you'll pay it off a little more than two years faster. If you double that payment to $500, the 30-year mortgage gets paid off 13 years faster and the 15-year mortgage four years faster.
The early payoff timeline works for mortgages under $1 million, Hogan said, but most millionaires don't have a mortgage that high. The average millionaire lives in a modest home, according to Hogan's research. They also live in a ZIP code where home values are below the national average of $205,000, and more than half live in neighborhoods where the average household income is $75,000 or less.
That's smart considering that where you live plays a huge role in how much you save and spend, according to Sarah Stanley Fallaw, the director of research for the Affluent Market Institute and coauthor of "The Next Millionaire Next Door: Enduring Strategies for Building Wealth."
She found that if you live in a pricey home in an affluent neighborhood, you're more likely to mirror your neighbors' consumption habits, affecting your ability to accumulate wealth over time.
Living in a home you can easily afford is the key to building wealth, Stanley Fallaw said.
"Keeping housing costs low is smart, no matter how much money you have," wrote Business Insider's Lauren Lyons Cole, a certified financial planner. "The best financial move you can make is to literally move to a less expensive home."
