Thinking about buying a house? Perhaps you have a house already but are thinking about refinancing to get a lower interest rate. But if you get a mortgage what kind should you get? A 30 year mortgage means a lower payment, so that’s better right? But a 15 year mortgage means you’ll pay a lot less in interest, so maybe you should go that route. How do you decide?
What about the interest savings?
First lets look at interest. If you are paying interest for fewer years then you’ll pay less overall. That’s logical. But how much difference does a 15 year mortgage vs. a 30 year mortgage make?
As an example, let’s say you are looking to borrow $200,000 for your home. Checking Bankrate.com the current average rate on a 30 year fixed rate mortgage is 3.47%. The current average on a 15 year fixed is 2.84%. This points out another advantage of a 15 year loan as rates are usually lower.
So if you were to borrow $200,000 for 30 years at 3.47% and assuming you just made your monthly payment each month as planned, you would pay $122,107.65 in interest.
Now, let’s take that same scenario except the loan is a 15 year loan at 2.84%. The interest you would pay is $45,848.52.
That’s a savings of $76,259.13!! You might have thought that by cutting the term in half you would have cut the interest in half. But as you can see from this example you actually would be eliminating almost two-thirds of the interest you need to pay.
But what about the mortgage payment?
Ok. Well that’s great you say. Saving on interest was expected, but what about the payment? Isn’t my payment going to be a lot higher?
Well, yes, naturally it will be, but not as much as you might think.
Looking back at our example, on that 30 year mortgage on $200,000 you would be paying $894.74 a month. If you had a 15 year mortgage that mortgage payment would be $1,365.83.
So your payment is not double. It is actually only $471.09 more.
Now I understand that’s still a decent chunk of change. But consider with a 15 year mortgage your payment is only about 50% higher but you will pay only a third of the total interest. That’s a pretty good deal!
Best of both worlds?
So if my payment is lower on a 30 year but I save on interest with a 15 year, I could get the best of both worlds by signing up for a 30 year, but then paying it like it was a 15 year, right? That way if I have a financial set back I have the lower payment I’m committed to but as long as I keep paying that extra amount I’ll still get my interest savings. It’s the perfect solution.
Or is it? Yes, it is true that if you have the discipline to make the payments each month like it was a 15 year mortgage, you will get the same interest savings that you would have had you signed up for the 15 year mortgage. The problem is there is a very high probability you won’t do it.
Something always comes up. Unless you are very unusually disciplined, you will find that there is always something you need to do that month. So for just this one month I’ll make the 30 year payment, but next month I’ll pay extra. I promise!! Then next month comes along and something else comes up. Then something else. And on and on. And the truth is despite really good intentions, very rarely do people pay off a 30 like a 15.
What does it mean to have no mortgage?
So here’s one final consideration. If you have a 15 year mortgage, then obviously years 16 through 30 you will have no payment because your house will be paid for. What if instead of just spending that extra $1,365.83 that you now have in your budget, you invested it instead. You are used to not having that money to spend anyway.
Let’s say you put that $1,365.83 in a good mutual fund each month for 15 years. Your investments by that year 30 would be worth $689,165.11!! Combined with the interest savings you are more than 3 quarters of a million dollars ahead by getting that 15 year mortgage!
So at the end of 30 years you could have a paid for house. A good thing! Or you could have a paid for house and almost $700,000 in savings. That’s a very, very good thing!!
So, perhaps you say 12% is no longer realistic. (Even though that’s historically what the market has earned over time.) Let’s be really pessimistic. Let’s say your investment only makes 4%. You’d still have $337,238.16 saved plus your paid for house.
So which mortgage do you get?
The best alternative is to save up and pay cash. Impossible? Actually, the Wall Street Journal reported that in 2010 28% of all home sales were paid for in cash.
But if you decide not to go the 100% down route, you have to decide for yourself which type of mortgage you will apply for. It is true that there is a little more risk with the higher payment. That risk is mitigated though by the fact that you really shouldn’t be buying a house until you are debt free and you have 3-6 months of emergency savings in the bank. Then if you have a major emergency like a job loss you have that cushion.
This can be a life changing decision. If you can manage the payment, a 15 year loan gives you the opportunity to really change your family tree from a financial standpoint. If you have to get the 30 year payment to afford the payment, I would strongly urge you to consider buying a little less house. The long-term benefits to the 15 year mortgage are just too great!
How would it feel to have a paid for house?
Photo credit: Images_of_money (creative commons)