I am sure you have seen it by now, but there is a Coffee Calculator that was flying all over the web a few weeks ago that shows how much money you would have if you invested the money you spend on coffee at Starbucks. The website is hilarious and quite frankly as a certified coffee addict, I know for fact my portfolio is thousands of dollars smaller than it would be if it were not for coffee. Nevertheless, I believe man should have a few vices to stay sane.
The website uses very simple linear logic of evaluating the lost opportunity of not investing money that is spent on the coffee. Instead of spending $3.00 on coffee, invest the money at x% return and you will soon be rich!
While the site is entertaining, what it fails to do is point out that you can use this type of logic on any part of your life. For instance, if I chose to drive a beat up lime green Pinto instead of my Volkswagen Touareg V8, I could have invested the money and would be x richer. Or better yet, if I chose to wear K-Mart kickers with hard ass rubber soles instead of my butter soft leather Ferragamo loafers I would also be a bit richer. Come to think of it, if instead of buying a limited edition Panerai watch, I should have bought the plastic digital Timex. I also probably should have reconsidered taking my wife to Aruba for our honeymoon too. We could have stayed here in Chicago and I would be much richer. I also should have not bought my bungalow in Oak Park and instead rented some 500 square foot studio next to a crack house in West Chicago. Hell, I would have been a millionaire by now. Oh the shame, what horrible financial decisions I have made with my life!
There is no part of your life that you cannot make this argument. In fact, what the examples above do is point out the absurdity of this line of thinking. See, you can make a numerical argument, but most of life’s decisions are not black and white and cannot be boiled down to a number. The Touareg costs dramatically more than a Pinto, but is much more fun to drive and reliable. Wearing Ferragamos is like heaven to your feet as opposed to some odd form of Guantamo Bay torture from K-Mart kickers. My Panerai watch will be passed on to my kids and will probably appreciate in value as a collectors item. My point is the numbers cannot quantify the intangibles. In fact, drinking coffee for me is a stress reliever and I know it is a complete waste of money, but there is a great comfort in my cup of coffee that simply having an additional $3.00 in my pocket will not provide. I also think you can see that living your life in terms of lost opportunity cost would probably make you miserable. You would be richer, but miserable. You definitely don’t want to be around me prior to my morning cup of joe.
How does this relate to mortgages? This line of thinking is what most rate shoppers do when selecting mortgage providers based purely on the lowest rate. You simply take monthly savings from the lower rate and carry it out over the life of the loan. The next thing you know, you saved a Gazillion dollars! There is nothing wrong with this logic except that many people do not do it in the context of it being the largest financial transaction of your life. Like with most of life’s decisions, mortgages are also not a black and white decision. Does having a low rate matter? Yes, but it isn’t the only factor that matters with your mortgage. You also have to consider if the lender can perform as promised – meaning you actually close on time at the rate promised with no hiccups along the way. What most consumers fail to understand is that a rate quote is just a rate quote. It doesn’t mean anything unless the loan closes. Some of the most fervent rate shoppers I come across use the linear logic of lost opportunity cost, but will think nothing of dropping $40k for a loaded 3 series BMW instead of a more fiscally prudent Hyundai. Both get you from A to B. Sure the BMW pulls more chicks, but so would having the extra cash in your pocket.
I understand why otherwise rational people act irrationally in the context of their mortgage. For most people, their mortgage payment is their largest monthly obligation. It is not a small feat to pay it and you can physically see the money going out the door every month. On the other hand, your coffee addiction is not as visible. You don’t necessarily feel the pain of spending $3.00 and you don’t tie it to anything in particular. With your mortgage, a payment of $1950 is better than a payment of $2000. It is right there on the payment coupon book, so most people disconnect themselves from the intangible aspects of the transaction and focus on the bottom line. In addition, obtaining a mortgage is not something that people do frequently so they don’t really understand the pitfalls of home buying and mortgages and why cheaper does not equal better. As such, it is difficult to explain that getting a mortgage is not as simple as calling around asking “what is your rate” and voila, you have a $500k loan.
Take this excerpt from an email I received from a client a couple of months ago:
“After careful consideration of all the alternatives available to us for financing, we have decided to use another lending institution… our decision was driven by available interest rates, closing costs…”
I closed this borrower’s transaction last week without a hitch. The other lending institution couldn’t close the loan because of the borrower’s employment status. Of course, this didn’t pop up until a little over two weeks from closing and borrower had $15k in earnest money that they were about to kiss bye bye. I am sure on my client’s next purchase or refi, he won’t be so focused on whether another bank is quoting .125% lower rates even though it would have made him a millionaire.
