1. Most people when looking for a new home loan will always say that they want to be able to pay the home off as fast as they can. If they wanted to be able to pay the home off as fast as they could then why didn’t they save up a 50% down payment on the home instead of financing 100% of the value of the home? This is a common question that most mortgage bankers and mortgage brokers kind of chuckle to themselves about when people want a 15 year fixed rate mortgage. Sure, paying off your home early is a great idea and doing it will save you thousands of dollars in interest over the life of the loan. In hind sight how many people actually pay their house off. It’s less than 25%.
2. The one characteristic of a 15 year mortgage that everybody likes is that they typically have a lower interest rate than a 30 year loan. On any given day the stock market will produce interest rates that are at leat .25% less than what a 30 year fixed rate mortgage will. Since the American population is so interest rate focused all that they hear is that they are saving at least .25% in interest rate.
3. Now the home owner is saying off course I would like to get a 15 year fixed rate mortgage over the 30 year mortgage. Why wouldn’t I want to get one? The house would get paid off 15 years sooner and you would save a bunch of interest over the life of the loan.
4. Now its example time. So the home owner is all geeked about the 15 year mortgage and saving .25% interest. Let’s see what some monthly mortgage payments are going to look like. Let’s use a $175k home loan with a 6.5% mortgage rate : 15 year mortgage payment is $1,524. Out of that payment $947 is interest and $577 goes towards the principle. As you can see you are knocking down the balance of the mortgage pretty quickly. Over a 1 year time period you would have paid roughly $577 x 12months =$6,924 of the mortgage down.
5. Now lets see what a 30 year fixed rate mortgage payment would be using $175k at 6.75%: 30 year monthly payment is $1,135. Out of that payment $984 is going to interest and $151 is going to principle. As we can see from the two above there is a difference of about $389 in monthly payments and $426 more of the 15 year payment is going to the balance.
6. This looks great and all because now we see we are saving lot’s of money in interest and the balance is going down quicker. So everything is great right, right? The answer is no. What most people do not ever stop back to think about is the future when they are making the biggest financial decision of their future. They think they are making a smart play by committing to paying off the house but what they are really doing is never preparing for those “what ifs.”
7. What do you mean by a “what if?” A what if is for example having kids and then more kids. How about your house needs a new roof or a new driveway. What about when your kids are about to go to college and you need $50k to pay for that. How about car repairs? And what about your retirement funds? You cannot leave those behind at all. You need to be saving for those because all of those expenses are going to continue to go up. Many people take the 15 year mortgage and a year down the road call up their mortgage person looking for ways to lower their payments on thier loan because the payment is just to high. The quickest fix of them all is to finance if from the 15 year mortgage to the 30 mortgage. As you can see from the example that is almost $400 going into their pocket and that is without rolling any other debts into the home loan. Many people also have to refinance into the 30 year loan to avoid foreclosure.
8. When you take the 15 year fixed rate mortgage you are locking yourself into a higher payment when you could have the flexibility of a lower mortgage payment with the 30 year mortgage. That extra money you pay towards the mortgage every month could be going into a savings account, retirement account, an emergency fund, mutual funds, etc that could be earning you money every month and year that you will need eventually.
9. Now what about for the person who makes good money and has all of those other things in line. They contribute to all of those retirement accounts, savings accounts, etc and has always done a 15 year mortgage because that’s what they feel comfortable with. A smart mortgage broker or banker would say “Mr.Client you have taken a 15 year mortgage out every other year for the past 5 years to take more cash out of your home for repairs or something else. Why don’t you just take the 30 year mortgage and save the money and just make larger payments every month. This will save you the $2k in closing costs that you get charge. So far you have spent $6k just in closing costs so you can make a biiger payment.” “I can make a bigger payment?,” says Mr.Client
10. Yes, of course you can pay more. A mortgage should be looked at just like any other bill. If you want to pay more than pay more. Going back to our $175k example above at 6.75%. A 15 year payment is $1548 a month. This means that if you took the 30 year mortgage at 6.75% and want to pay it off in 15 years you would put $1548 – $1135 = $413 a month on top of your payment and the house would be paid off sooner. What is great about going this route is let’s say that maybe you lose your job or a car breaks down or things are just getting tight with expense, you then lay off making the larger payment that month and just put the money in your pocket. All that you need to do is make the $1135 a month payment anyways so you do not get any mortgage lates. Then when things are under control just catch up if you want too. Now there is no reason to refinance the home every couple of years because now you are in control of the mortgage not having it in control of you. That $413 x 12 months = $4956 in cash that you could put away in savings or use to pay other bills. Over a 5 year time period this is $4956 x 5 = $24,780. Think about if you had kids that were 13 years old and you have not saved up a dollar for college education. You could save up that much and earn interest. $24,780 earning even just 3% will earn roughly $3500 in interest by doing nothing. So now you have roughly $28k in your pocket. You still get the tax write off on the home loan and know your kid might not have to make student loan payments. As you can see the 30 year fixed rate mortgage gives the home owner more control over what their finances are than a 15 year mortgage. The interest rates do not really matter at all because knowing that you are not going to have to refinance your home saves the money in closing costs. If you want to pay more than do it, if not keep the cash and invest it.