30 year mortgages make the monthly payment smaller, which reduces the monthly cost of housing, BUT you end up paying more interest since you aren't paying principal off as fast which means the total long term cost of the asset is more due to compound interest. A 15yr mortgage takes more out per month, but it's cheaper overall since you're paying off principal faster and interesting isn't accruing or compounding as quickly.
I think it's possible to "game" the system by getting a 30yr mortgage but set it up so any extra payments above and beyond the minimum amount get applied against principal - in effect reducing the amount of money they can leverage interest against. Then you make as many extra payments as possible over the life of the mortgage and pay it off ASAP.
To fix the problem of all your payment going to interest, look at a shorter term. A 15 year mortgage is much less popular than a 30 year, but you start seeing a difference in the outstanding principle right away.
Depending on the rates and down payment, it's not uncommon to need >10% gains in the invested difference for the 30-year to beat the 15-year mortgage. The 15-year mortgage has proved to be much more advantageous in my case.
Yeah, but there's no prepayment penalty so if the interest rate was the same and you're good with money you should take the 30 year mortgage and pay double every month. That way you have flexibility to half your mortgage payment if you run into financial hardship in a decade.
Obviously it you can't control yourself with money then don't do this.
When I bought my house I went with the 30 year mortgage. The interest rates between 15 years and 30 years were not hugely different and my 30 year interest rate was so low. I ended up really glad I did.
You're still (usually) allowed to pay back a 30 year mortgage in 15 years by making extra payments against principle. So the total amount of interest paid would be equivalent.
The advantages of getting the 30 yr are
a) You don't have to keep paying that extra principle on your 30 year mortgage. If you lose your job or whatever, you can fall back to making the regular payments
b) The time value of money aspect. My mortgage is currently well below inflation. $151894 in 2035 dollars might be more expensive than $215838 in 2060 dollars. Especially if you're able to reap the tax benefits of mortgage interest.
Yeah but you can (usually) just pay the same amount with a 30yr as if you had a 15yr mortgage, but you still have the added security that if you fall into hard times, you have a lower mandatory payment with the 30yr.
Also you’re correct about the higher cost of the mortgage, and this doesn’t really work as well at 6%… but if you had a 3% mortgage, you would have better returns taking the 30 year and investing the difference each month. The amount of money you’d make from the returns on that would, on average, be greater than if you paid off the mortgage in 15, then started investing. But yeah, doesn’t work as nicely at 6%.
> Even people who can easily afford a 15 year loan will choose a 30 year because the 0.5-1% interest rate is lower than the expected returns of something like stocks, so it makes sense to stay leveraged. There are also tax benefits to paying interest (but not principal) on loans, but these are way less important since the trump tax reforms.
On the other hand, it probably reduces risk to take the 15 year loan if you can afford the payments, in order to more aggressively build home equity and shield yourself from a sudden shock/downturn. If rates shoot up after, say, 5 years (and home values drop 20%), someone who's made 5 years of payments on a 30 year loan will be way underwater, whereas someone who's made 5 years of payments on a 15 year loan still has positive equity.
It might've been just because I got my mortgage at a weird time, but when I refi'd there wasn't really a benefit to going 15 year. The interest rate was basically the same, so it seemed pointless.
At any given instant, your monthly payment for a 15-year will be higher than for a 30-year. You're right that if you can't afford it, then you shouldn't do it.
If you can possibly afford the payment for a 15-year: in 15 years you'll have a monthly payment of zero, because you'll have paid it off. After a few years, you'll have started paying off the principal.
And, of course, if rates go up (as they have), then in a few years the monthly payment for the 30-year will be approaching what you would have paid a couple years ago for a 15.
For sure. In another post I compared today's rates for 30Y and 15Y with 15 years of 4% returns and still came out (slightly) ahead. I'm interested in how you determined that the 15 year was more advantageous (did you calculate what your cash flow would have been with a 30Y?) and if it was a big advantage because you perhaps got lucky with market timing and finishing up your mortgage when the market is low (which really isn't something a new mortgager can rely on), or because the interest rates were at parity with the investment returns of that era, which would make it smarter to pay off quickly.
Guys, don't downvote him. Many parts of the world do it like that- your 30yr mortgage is really a series of 5yr balloon amortized for a 30 year period. They don't have the option of a true 30yr fixed.
You're missing the point, or you didn't read the post.
A 15-year payment is higher, of course, but after 15 years you've paid it all off. After 5 years, much of your payment is going towards principal, not interest. You can do this calculation in a spreadsheet.
The question is: when rates go up, at what point does the new 30-year monthly payment equal the old 15-year, when rates are lower?
> If budget allows, you can make additional payments towards the principal.
He wasn't worried about paying off the 15 year mortgage in 10 years. He was worried about getting a 15 year mortgage and then sometime happening so he couldn't afford to pay it off in 15 years. With a ARM you get the flexibility of lowering your payments to the minimum - which will pay it off in 30 years if bad times happen, while getting the lower interest rates of a 15 year loan (for the first X years, then who knows), and if you may the 15 year loan payment it is paid off in 15, while if bad times come you drop to the 30 year repayment amount and have more money to deal with whatever.
It can be a very good idea for someone who plans to pay off their mortgage early. If all goes well it is no worse than a 15 year mortgage, but when (really, if is unlikely) something bad happens you have more flexibility. Of course if interest rates go up you will get burned, which is why I go with a 30 year fixed rate that I pay off. I could probably afford payments on a 15 year loan, but I'm not willing to risk it.
This was the approach that made the most sense to me.
Purchase a house where you can afford the 15-year fixed mortgage, but take out the 30-year fixed mortgage. Pay it off as if it were the 15-year fixed (ensure that your loan has no penalties for prepayment or extra payments, and that 100% of extra payments go toward the principal).
If things go smoothly for you, you’ll pay a marginal amount of additional interest (because your % will be higher as a 30-year than a 15-year). However, if you run into cash flow issues, you have a good amount of reduction in mortgage payments that you can make while keeping the bank completely satisfied.
Yes, you can get a shorter term loan and have a lower interest rate- 15 years is also reasonably common, and fixed rate products exist at 20 and 10 years respectively. Adjustable rate and 5/1 or 7/1 products exist as well, but they aren’t as popular or encouraged by regulators, as they played a role in the 2008 financial crisis.
As to why go for a 30 year loan instead of a lower interest rate 15 year the answer is basically cash flow and opportunity cost. A 15 year loan may result in paying less interest, but the monthly interest + principal payments are more. Your average borrower will qualify for a larger 30 year loan because the analysis is based on their ability to afford the monthly payments based on their current income.
Even people who can easily afford a 15 year loan will choose a 30 year because the 0.5-1% interest rate is lower than the expected returns of something like stocks, so it makes sense to stay leveraged. There are also tax benefits to paying interest (but not principal) on loans, but these are way less important since the trump tax reforms.
And I just reread your question, and I think you are asking about 5/1 loans. The reason there is that a) interest rates so fluctuate, a lot- they were above 9% in 1991. With a 30 year, you can choose when you refinance (there is no penalty to paying off a home loan early in the US) whereas with a 5/1 you might find yourself getting forced into a higher interest rate- potentially much higher to the point it’s unaffordable. 5/1s also actually have a higher interest rate than 15 years currently, as they aren’t considered “conforming” to various US government programs.
reply