When acquiring a mortgage (whether for a new home or refinancing an existing one), strongly consider the available options. That is, don’t assume a 30-year mortgage is the “way to go.”
In viewing mortgage rates available (at time of writing) we have the following “fixed rate” options to consider at my bank:
- 15-year at 3.5%
- 30-year at 4.375%
Let’s assume the home we wish to acquire (or the remaining balance of the one we wish to refinance) is $200,000.
The 30-year mortgage would require a monthly payment of $998.57 and the 15-year would require a monthly payment of $1,429.77.
Some may say: “Ouch, the 15-year option “costs” too much. I can’t afford that.” Perhaps the monthly payment is too high for the budget, but the “costs” are actually LOWER for the 15-year mortgage. Consider this:
If we add up the total monthly payments for each of the above options, we will save a SIGNIFICANT amount on the 15-year mortgage.
- 30-year mortgage) total of all monthly payments = $359,485.20. This option “costs” $159,485.20 more than the price of the home!
- 15-year mortgage) total of all monthly payments = $257,358.60. This option “costs” only $57,358.60 more than the price of the home and, more importantly, it costs $102,000 less to acquire the home than with the 30-year option above.
Note: To simplify matters, I’ve excluded the points paid at closing (which are often lower for 15-year mortgages), as well as tax and insurance.
The key point: we can save hundreds of thousands of dollars by selecting a shorter mortgage period. And, we can save further by accelerating payments. That is, if we are in a mortgage for which there is no benefit to refinance we can dramatically shorten the loan period (and reduce finance charges / costs) by increasing our monthly payment. Building on the prior post on eradicating debt, once the home mortgage is at the top of the prioritized “kill list” we can take the available cash that was previously being applied towards other debt and apply it directly to our home mortgage.
Consider this new found knowledge when refinancing. That is, don’t be coaxed into refinancing a loan that may have 15-20 years on it, into a lower interest rate AND extending the mortgage out another 30 years. While the monthly payments will be (far) less, the “costs” of acquiring the home will go up. An exception, of course, would be if this is part of your debt eradication plan and you have committed (to yourself) the difference between your old and new monthly (mortgage) payment towards higher interest debt.
Hope you found this simple math equation helpful towards shortening the distance to your financial freedom.
For more in-depth guidance on becoming financially fit, consider this recommended reading (if you haven’t already done so).
We took out a 15 year loan on our house which costs us about $255 extra a month. By the time our youngest who is 6 now graduates high school we will be free of a mortgage. We have a plan to roll 25% of our tax return each year back into out loan and be done with it by the time she is in 8th grade. I will be 44 and. in the prime of my career with no mortgage payment !! And an excess rental income as a cherry on top!!!
MIchael – that is absolutely fantastic!
Good decisions now put you in a position for HUGE payoffs down the road. Great job!!!!
Good article, Craig — but as a mortgage professional, I would just add “there’s no right answer”. If you’re only focused on total cost over the life of the loan, you’re right, you should probably look at a shorter term (and lower rate). Many people have other things up their sleeve, such as needing to lower their payment to solve cash flow issues, needing to take out cash for renovations, etc. (thus increasing their loan balance and possibly their payment). Another thing to consider is whether you are going to be needing to borrow money for any other reason in the near future. If you have a lower *required* payment showing up on your credit report, it will be easier for you to qualify for that boat loan (ha ha) or whatever other thing you might need to borrow money for. Key word=required. Just because a 30 year loan only requires you to pay x doesn’t mean you can’t pay x+ when you make your payment. Bottom line – there is no ‘one size fits all’ here. And points are not necessarily less for a 15 yr loan, btw. If you’re considering paying points at all, definitely do the math!! Doesn’t always make sense to do so, all depending.
Thanks Carol – Good perspective!