By Jeanne Roberts
Thanks to lower mortgage rates and creative bankers, the standard mortgage that our parents would have recognized – 30 years at a specified rate of interest with fixed and equal monthly payments – is no longer the rule.
In fact, it may soon become the exception, but not because first-time home buyers can afford the larger payments inherent in shorter-term loans or because homeowners refinancing from high pre-recession interest rates have the extra cash just lying around for the refinance fees.
No. It’s because shorter-term loans mean true home ownership before middle age looms, instead of ownership deferred until the fledglings have all left the nest and proven that they can fly.
What are the advantages of these shorter mortgages? One is, of course, less interest. For instance, a 30-year fixed rate mortgage today will cost borrowers 4.433%. This means that a $300,000 home with a $50,000 down payment, over 30 years, will cost just under $200,000 in interest payments over the lifetime of the loan, which is almost the equivalent of another home.
Change those terms to 15 years, and the interest rate drops to 3.691%. Not a lot in the short term, but over the life of the loan borrowers will save a whopping $125,000 in interest ($200,000 less the $75,000 the loan now costs in interest).
That $125,000 is almost half the value of a new home, particularly in this post-recessionary economy. The trick, of course, is being able to afford the larger monthly payments. For a 30-year loan, that tag is about $1,569. For a 15-year mortgage, it jumps to $2,123 per month, which means fewer business lunches, almost no dining out and definitely no Starbucks for many of us, a sacrifice few caffeine addicts are willing to make.
Assuming the buyer is willing to live frugally for 15 long years – and frugal may mean grocery-store food, Target clothing, and the same-furnishings shelter with no frills for the duration, a shorter-term home loan can be a very good idea. It’s not so much get in and get out, as get out from under a lot faster. In addition, the 15 year mortgage incorporates fast-track equity building that puts borrowers on a more solid financial footing as far as buying that new car or taking that once-in-a-lifetime vacation goes.
Yet sometimes it isn’t about money. For example, as one Pennsylvania financial planner points out, sometimes there is a second right answer, or there are better things that can be done with the money, and they don’t include cars or vacations.
One could, for example, drop the extra $550 into an IRA or a 401K, or even invest in mutual funds or annuities. This means that, once the house is paid for and retirement looms, borrowers will actually be able to afford to quit working, provided another recession doesn’t intervene.
But don’t let your banker talk you into a 30-year mortgage based on its tax benefits if you can afford to pay off your home over 15 years. Of course, you will have a bigger yearly interest deduction with the first type of loan, but that money from the government represents only a small part of the much greater amount of interest you are shelling out.
Also remember that owning a home is not the be-all and end-all of existence. If you can’t pay your mortgage and also afford necessities like life insurance or building a modest retirement fund, you probably need to bite the bullet and borrow over a longer period, even if it does mean paying out more in hard-earned dollars.