Trying to see if PRC can help reveal any financial benefit between either paying all cash for a home or taking out a mortgage. Assume all other variables are equal across the tool, the only difference is that in S1 I use cash and in S2 I take out a 15 yr fixed rate mortgage (all this entered into Expenses>Property).
Then I run a "Specified expenses with smoothing" (using Monte Carlo) analysis for each scenario. S2 always results in a slightly higher annual spending amount compared to S1, which in turn results in a lower end-of-life net worth (compared to S1). So....to adjust for this difference in NSDS spending, I manually lower the S2 amount to match the S1 amount, then compare final net worth numbers again. The idea being to "equalize" all variables as much as possible to reveal any meaningful difference in between the mortgage/cash scenarios. At this point, whichever scenario produces the highest final net is interpreted as the "better" financial option.
I know there are other reasons to choose cash vs a mortgage - but for now, I'm only trying to get an answer to the financial benefit aspect of this decision.
Any thoughts on this approach from the forum would be appreciated.
Hoping the forum will weigh in on this, as well as Stuart.
@nc-cpl I don't think I'd recommend using Monte Carlo consumption smoothing for this because it introduces some variations from one run to the next due to the use of random numbers. The best way to compare two options (in my opinion) is to simply do a direct comparison between the two scenarios using the Analysis > Fixed Rate Comparisons page. Whichever one yields the best long-term result is the least expensive option.
Stuart
Makes sense and pretty straight-forward. Thanks Stuart.
@nc-cpl I have not used consumption smoothing so can't comment on that. However, I have utilized the model to compare staying in a home with a mortgage and keeping a rental to a case where I was selling a home to eliminate the mortgage and free up some cash and moving into a rental. A few more moving parts but I felt comfortable with the results. One thing you may want to consider doing is using the sensitivity tab and see how sensitive the scenario comparison is to your ROR assumption. As a simple but not complete check, compare your mortgage rate to the ROR on the cash that you would use to buy the home. If the ROR on the cash is higher than what your mortgage rate is, then a mortgage might be financially beneficial.
@golich428 Correct me if I'm wrong, but doesn't PRC allow you to factor in real ROR on cash (on Financial Assets>Asset Allocation screen)? And the mortgage rate (as of today) is factored in on the Expenses>Property screen. So I think those two variables are already taken into account - and when considered along with everything else in your model, wouldn't Stuarts suggestion of comparing the (ending) Fixed Rate Projection between the All Cash vs Mortgage scenarios be the best approach?
@nc-cpl I think you are correct; I just have a preference to check and see how robust my assumptions are as well as do some simple calculations to test reasonableness. I also like to view the path of the projections to see if one scenario dominates the entire model life or if there is a cross-over and when the cross-over occurs. Everybody probably looks at things differently depending on their preferences.
