I participated in a discussion over at the Get Rich Slowly forums about mortgages today. Strangely enough there was a lot of talk in my office about refinancing mortgages because of the Fed rate cut. (Even though rate cuts don’t necessarily guarantee lower mortgage rates.) I try to be the voice of reason in my office, which can get pretty frustrating with all of the random financial ignorance that gets thrown out.
But anyways, let’s talk about mortgages. To start, at no point will I ever support anything other than a fixed, regular mortgage. None of the adjustable rate mortgage (ARM), option-ARM, or interest-only crap. Get a fixed mortgage, get a fixed payment, and pay it on time. Simple enough.
The only question that remains then is payback period. The 30-year fixed rate mortgage is the standard in the industry. Your parents likely had one, and their parents before them. The close cousin to the 30-year fixed is a 15-year fixed rate mortgage. Your payments are higher, but you are paying more principle back with each payment than a 30-year fixed payment. You save interest (slightly lower interest rate and shorter term) and cut your time with the mortgage in half.
Running the math: 30-year fixed versus 15-year fixed
I’ll use data that is current as of yesterday evening. Bankrate publishes national averages for various types of mortgage rates. As of yesterday a 30-year fixed comes in at 5.53%, a 15-year fixed comes in at 5.26%.
With both mortgages we will assume:
- $250,000 home value
- $50,000 down payment (20%)
- $200,000 mortgage (80%)
- all other costs identical (closing, fees, etc.)
Now let’s run the math on the monthly payment.
Note: I made a typo in my original calculations when this was posted in December 2008. The old, incorrect values have lines through them and the correct numbers are added directly to the right. Updated April 2009.
- 30-year: $1,339.35 — $1,139.35
- 15-year: $1,608.81
Difference in payments? $269.46 – $469.46
What if you pay the 30-year fixed like it was a 15-year fixed?
If you get the 30-year fixed and apply the pay the additional $269.46 $469.46 each month that you would have spent on the 15-year (and do it consistently, every single month) you shave off 10 years and 9 months 14 years and 6 months on the loan. That brings the total length down to a little more than 19 years 15 years (actually 15 years and 6 months).
This may seem to point toward getting the 15-year fixed. You’re saving more than 4 years worth of payments (and additional interest) by locking your payment in for 15 years.
(This now heavily favors my original opinion of getting the 30-year mortgage and paying it like a 15-year mortgage. You pay it off in nearly the same amount of time while getting payment flexibility. Granted, if you don’t add the extra into every payment your payoff date will be expanded out further than calculated.)
But I disagree. While you will save money with the 15-year mortgage, I prefer the flexibility of a 30-year mortgage. The lower payment builds in a tad bit more of a buffer for your finances in case you lose your job or some other emergency comes up. You can choose to add to your payment each month if you are able to — act like it’s a 15-year mortgage. But if something comes up that’s a little bit less stress on the budget. You aren’t forced to make that higher payment every month.
Let me finish by saying if you can afford a 15-year fixed… then by all means, do it! The above advice is for the people that would be over-extending themselves by going the 15-year route.
To all of you with mortgages, what are you in? ARM? 30-year? 15-year? I’m curious to see how many are on the 15 versus the 30-year. Leave comments!
***UPDATE:*** An awesome reader informed me of a serious typo in my calculations.
Originally I had the 30-year mortgage payment at $1,339.35. That is incorrect. The correct payment is $1,139.35. The difference in payments is $469.46.
That’s a $200 difference and it makes a huge difference in the payoff of the 30-year loan is significant.
I re-ran the calculations and if you applied the difference in the 30-year and 15-year mortgage to the 30-year loan, the payoff is 15 years and 6 months. You end up losing 6 months worth of payments, not 4 years and 3 months as I originally calculated.
This further confirms my belief that the 30-year (if you are disciplined) is the better option. The savings between the two is nearly $500 and could make a significant difference in your budget if you got into a pinch. Yes, paying off the loan faster with a 15-year mortgage would be great. But a well disciplined payoff of a 30-year mortgage will work almost as well.
(And isn’t it amazing what a difference $200 makes!)
Another point this makes: don’t trust everything you read. Don’t trust my numbers. Trust your own. Do your own math. Call me out on mistakes.
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EVERYONE: I made a serious typo in my original calculations. A reader just e-mailed me to point this out. I’ve added an UPDATE to the original post.
Bottom line: You save even more money with a 30-year mortgage than I originally calculated. Applying the full difference to the 30-year mortgage will have you paying it off in 15 years and 6 months rather than 19 years. A serious difference!
Thanks for your continued readership and keep up the great discussion. I apologize for the error.
“If you took the extra few hundred bucks and blew it on latte’s, well then you have no excuse.”—exactly! Most folks SAY they’re going to pay a 30 like a 15 but rarely do. I’ll have to dig up the article but the vast majority of folks have ‘life happen’ and they chew up that extra payment. Think how many people rolled their consumer debt (groceries, vacations, clothes etc) into a HELOC, or 2nd of some kind!–so they’re financing a steak! Cool thing about 15 year mortgages is that they always pay off in 15 years—no extra work/math involved.
Re/ investing the difference—I’d rather live lower on the totem pole, invest 15% of my wages AND have a 15 year note. Call me crazy but I don’t like the idea of paying the bank 2-3x the interest on the 30 year note. That savings is again guaranteed—the stock market etc. can’t give you that assurance or return.
Whether it’s a 15 year note or 30 year note when it comes time to foreclose won’t matter of course—and whether you spend cash you have on hand or cash out investments to offset income lost due to job loss is only a temporary fix—that is not a house-saving/long-term fix. You need another job, right? And if that failed and you had to bail/sell the house, you’d walk away with a smaller balance with the 15 year no doubt about it. Taking the difference and investing it a. assumes people actually will do that, and b. doesn’t solve the real issue (job loss, major medical hit etc.). If you don’t get a new job, game over either way.
The ‘would you borrow $100k on your paid for house to invest in the stock market?’ question—–if you can make 12% on the stock market over time, and have a 6% note, you’re looking at 6% max return. If you account for inflation and taxes, you’re really coming out close to a couple % return. And again, I would bet 99% of the folks you ask that question to would answer “no”. Why? because their heart (where risk is measured) knows that it’s not worth the risk. Our conversation here has largely revolved around the calculator, and that does not paint the whole picture.
The choice is “make a couple of points in the stock market or have a paid for house”—especially today I think the answer is obvious isn’t it? You can only get foreclosed on with a mortgage!
@eric In a previous post, I answered the question would I borrow 100k on my house and invest in the stock market “no.” We’re in agreement on that point.
I think that if you have more investments (and less home equity) you have a larger cushion, and hence more time to look for a new job, but that is just my perspective.
“Accounting for inlation and taxes you’re coming close to a couple percent return.” How do you account for inflation and taxes? Please show me the accounting because I don’t fully understand your point in how the numbers work out.
@ Kevin. With that calculation change in mind, how does that affect your decision on the lump sum vs pay off debt as you go?
@dan, taxes on investments differ depending on how long you hold your investment. if you buy a stock and sell it within a year you are taxed at your income tax level. if you hold it for over 1 year you are taxed at the capital gains tax rate. right now it is currently 15% if obama doesn’t try to increase that tax. so basically if you hold it for a year, uncle same takes 15 cents for every dollar you made in your investment. also inflation is something you can look up. usually when estimating, you can use 3% as an estimate. Precise fluctuations can easily be looked up by looking up the long term risk free treasury rate from any website. St Louis Fed, the Us goverment treasury, etc. You subtract that off your growth rate as well.
Keep in mind, the 401(k) limit is now $16,500, that’s $33,000/couple. I’d prefer the 30 as well, and fund the 401(k) to the maximum. Money paid back to the mortgage is really money tied up until the house is sold. Sure you may get a HELOC, but that’s not a fixed rate. These are the lowest rates you’ll see for a long time. You’ll soon find you can buy 1 yr CDs that yield more than you are paying on that 30 year mortgage.
Others will have a different view, but I see nothing sacred about paying of the mortgage. High interest credit cards are another story.
RE: Keep a low mortgage payment and invest the difference.
Forget paying off your mortgage. Invest in a bond fund (6% return over 10+years) instead of paying extra.
Keep in mind this fact: mortgages are SIMPLE interest. If you invest in bonds (or stocks for that matter) you are gaining COMPOUND interest.
Compound interest is the key to wealth.
Gaining even 4% compound interest is better than paying off a 5% simple interest mortgage.
Food for thought. Even Warren Buffett keeps a mortgage on his home…and this is the reason why.
Matt, on a 30 yr, 6% mortgage, if one were to pay $100 along with their first mortgage payment, they would save $500 in interest. Simple interest would be $180 as 30 * 6 = 180.
Cite your source for Buffet having a mortgage. I don’t know that he does or doesn’t but I doubt that he’d bother with one.
Completely agree. Buffett has owned the same home since 1974(?) in Omaha. There is no way he has a mortgage!
I’m a simple believer that the longer you pay for something the more it costs. Hence, less time to pay-off equals more time for ownership to me. I am a big believer in accelerating mortgage pay-offs by aggressive prepayments. It is hard for someone to take a home away from you if you own it, but I have witnessed many retirment accounts of my friends, including my own, which have been invested in mutual funds for years drop by 40% in value. Recovery will take a very long time. Hence, I have a 15 year mortgage that I have been prepaying on and have I reduced the remaining time by 24 months (as of last month), That is a lot of interest money the Bank will not earn and I have saved. While I agree a 30 year mortgage provides you flexibility in money usage, it is still 30 years and that is a long time to prepay. Excellent question for pondering!
@dan—yes, Aspirations purse is right—say you’re making 12% in the stock market (just assume over 20-30 years) and you’re paying 6% on the mortgage. Take out 3-4% inflation and a couple % of your gain due to capital gains taxes and you’re about even comparing the 2.
People often forget taxes and inflation when doing that comparison. The other variable here is risk—and that too has a cost. If my house is paid for I reduce that risk to 0. I can’t be foreclosed on—however if I lose my job, and my 401k tanks AND I have a mortgage—different story entirely.
I’d also like to see the reference to Buffet having a home mortgage. I’d be shocked honestly. The guy is a cash player and is making out like a bandit now.
eric_wan – time to get your spreadsheet out. I don’t and won’t claim a 12% return is reasonable. But to suggest that the difference between a 12% return and 6% mortgage is minimal is nonsense.
The 12% return, if dividends and cap gains, is taxed at 15% max, yielding 10.2%. The 6% is deductible against ordinary income and my property tax/ state tax covers my std deduction, so 6% costs me say 4.5% (25% bracket). You want to assume 4% inflation? OK. The mortgage costs me .5% (that’s 1/2%) and the stocks return 6.2% real return. Tell me how this is about even. ( I would use 8% for stocks, 6.8% after tax, 2.8% after inflation. Not that huge spread, but still, a difference that adds up over time.)
12% was “rosy”—granted, I was starting there to illustrate. 10% or less is even uglier.
6% difference, – inflation
- taxes
- risk
= not a great argument for a 30 year note. That was the whole point of this thread really—that 15 years of additional interest/risk is offset by the great returns over that time.
And you’ve proven my point. 2.8% – risk is close enough to zero to confirm for me that that argument makes no sense. Everyone else lined up for 15 more years of risk and those awesome returns—more power to ya! ;]
Erin – First let me say, there is no ‘right’ answer. Only what lets you sleep best at night.
You talk about risk. But you are taking on ‘more’ risk for those 15 years by committing to the higher payment, aren’t you? Sticking with the 6% mortgage/25% bracket, it would take a 5.29% gross return to break even using 15% cap gain rate. If one is disciplined enough to put that money aside, they will have more than enough to pay the mortgage balance at the end of 15 years, but during that time, they’ll have the money should an emergency arise. 10 years into your 15 year mortgage, what would you do if you lost your job? With no income will the bank lend to you?
What if for someone the difference between 15 and 30 yr payment is the difference to being able to fund their retirement account? A matched 401(k). That change your view?
Nothing exists in a vacuum. For some, your plan is ideal, for others, not. People in general are so financially illiterate they wouldn’t even follow this dialog. Too bad about that.
True—I don’t want to sleep on the street—that’s one of my motivators. This conversation can’t happen in a vacuum either! Before you took on ANY mortgage, I’d hope you had a reasonable pile of cash to catch “life” as it happens—co-pays, roof leaks, dead engine etc.
You’re right on the math, but how many people really have that kind of discipline? like 3! Cool thing about the 15 is that it pays off in 15 each and every time!
If I lost my job, and I was diligent and had cash on hand I would struggle—likely working 2 or 3 placeholder jobs while the ‘good job’ hunt went on. But that isn’t any different than if I had a 30 year note—in fact I’d have more equity in my home so if I had to sell I’d likely walk away with a bigger chunk of $. And that’d be tax-free money to boot vs. having to cash out my 401k and pay taxes on it etc.
Re/ the 401k match—again in the context of life I would hope that the borrower would have that entry in his budget BEFORE he went shopping—so he could afford the house AND make his contribution. There’s no reason he/she couldn’t do that except for house fever! too much HGTV.
I agree—the sad part is that very few folks will read/adopt ANY of what we’re talking about here! That’s why I trend to the very simple/very conservative. It’s great to be able to have these discussions—too bad very few (none?) of these will happen at the loan officer’s desk!
As to “discipline”, what you want to do is automate the whole thing. Of course you would fritter it away if you left it someplace where it can be “frittered” from. Instead, put it someplace where it won’t require “discipline” to avoid frittering it away.
Get a separate checking account for the mortgage payment. Transfer the amount of a 15 yr mortgage payment into it every month from your regular checking account. And send in an auto payment for that amount to the mortgage company every month.
this sequesters the cash away from the rest of your money so it isn’t visible. And what isn’t visible cannot be mindlessly frittered away.
If something comes up and you want to drop the payment amount to just the required payment for the 30 year mortgage, then you will have extra in that second account. And will have to make it available for other uses. This little extra step required helps in getting across that it is an unusual thing and not something that will be happening all the time.
The one thing EVERYBODY has missed in the mortgage equation is this, any dollars you borrow are worth more now then in the future, hence the longer the mortgage the less those dollars are actually worth in the long run,due to inflation ,if the u.s. ever again suffers hyperinflation , which is quite possible, maybe even probable with the way the govt. is printing money these days [only a fool thinks its going to get better],those dollars you are paying the bank years from now will only be worth a fraction what they are now, which means a longer mortgage at this point is more beneficial, even though I always thought shorter was better, at least up till now.
So you bought you house in yuan or euros? inflation would affect the value of the dollar and the dollar-denominated asset as well.
If that kind of thing happens, saving a few bucks on your mortgage payment will be the last thing on your mind.
and yes, though the gov’t has gone quite far in ‘quantitative’ easing, there is no sign of inflation on the horizon like you’re talking about. Nor is there really any alternative to the dollar as a reserve currency—-someday, possibly, but not for years to come.
With mortgage rates as low as they are today, the average person is better off with a 30 year loan. With the lower payment you should be able to invest the difference and get a greater long term return. If you have a tough time saving and would just spend the difference, then the 15 year is a wise choice. Each person is different…
No they’re not. The average person has about $8500 in credit card debt, has no budget, is not saving for their kids college and really has no clue about financial discipline. The readers of this blog?….maybe they are atypical, but if you want to talk about the average American, they are relatively clueless—and in that light, a shorter term note is far safer, as the average American will NOT save the difference. They’ll spend it, or lease/get a loan on a new car etc.
And you are committing the fallacy of not including risk/taxes in your investment math—-the return on that difference is very dicey given our current environment of investments (where exactly can you guarantee a reasonable return right now?). I can guarantee you that inflation will rear it’s ugly head and taxes are only going up! ;]
I agree that *some* folks could make it work, but it’s not the slam dunk math-wise that you think—it’d take some luck! and the average person is just nowhere close to being able to make it happen—look at their track record.
The 30 year note is a banker’s creation—it has no basis in math as being a better “product”. It’s just what’s been sold primarily for years and years as the smart move.
I LOST MY JOB, BUT MY HUSBAND STILL HAS A JOB. WE HAVE ONE INCOME AND SINCE WE HAVE A 30 YEAR MORTGAGE, STILL I CAN PAY MY LOWER MORTGAGE PAYMENT. THE SITUATION WOULD BE DIFFERENT IF I HAVE TO PAY THE 15 YEAR, HIGHER MORTGAGE PAYMENT…
WE HAVE 401K, BUT IN THIS ECONOMY I WOULD HAVE TO TAKE OUT LOT OF MY SHARE TO GET THE SAME DOLLAR VALUE I HAD 5 YEARS AGO. I DO NOT EVEN TALKING ABOUT THE 10% PENALTY AND TAXATION.
I AM TOTALLY AGREE: GET THE 30 YEARS MORTGAGE, PAY EXTRA MONEY IN TO IT, BUT LIVE THE OPTION OPEN.
If you are say an Obstetrician who is always getting sued you WANT to have a big mortgage loan so the property is encumbered and lawyers can’t take it. Also you want to lease a car and put the max into a pension (off limits to creditors.)
As far as stocks MMAs CDs etc could put into a family trust but even that’s not bombproof
It is hard for someone to take a home away from you if you own it, but I have witnessed many retirment accounts of my friends, including my own, which have been invested in mutual funds for years drop by 40% in value. Recovery will take a very long time.
Sorry to hear that Aniko, but I bet you could make the difference by halting your contributions to your 401k. Don’t take out the money though—penalty + taxes is 30-40%!—ain’t worth it. I still don’t buy that as an acceptable reason to have a 30 year note, and you will get another job—don’t lose hope!
@TB…huh? that’s what malpractice insurance is for—which docs have to carry anyway. And leasing is the MOST expensive way to acquire a car. Your logic would dictate leasing everything your whole life—no equity built up so you can’t get sued and have it taken away? Buy insurance—transfer the risk–that’s what it’s for.
@ Finance—not only is it hard, it’s impossible. Foreclosure only happens with a mortgage balance.
eric – if inflation returns, isn’t it better to be a borrower than a lender? I have the bank’s money, fixed at 5.24%. In the 14 years since I moved in inflation has made the value of the remaining balance I owe less than half. i.e. these are cheaper dollars.
As far as risk is concerned, I’d rather take the 30 and know that I have the extra cash each month, that small rate difference wasn’t worth it to me at first.
On the other hand, when a rate drop was enough to refinance to a lower term and not have the payment go up too much, I did that, and now have less than 7 yrs left, so all in all about 20 years, but at the beginning, the 15 yr payment would have been tough.
Great rate!—but you’d have a cheaper rate w/ a 15 too, and you’re building equity faster, so in fact you’d still be better served as your home would appreciate faster with that rising inflation—of course you need to have a fixed rate either way in that case! if you owned outright, your house (likely your largest single asset) will ride up with the tide—no risk either.
True, I understand that the 15 is a tighter plan, but *most* people don’t do a written budget—-so they really piss away a lot of money since they’re not tracking it. I suspect more of the folks that read this actually do a budget that they stick to BEFORE the month begins, but the vast majority of American’s have no clue where their money is really going. That is a small exercise that could save you 100′s of thousands in interest—-just to sacrifice and only eat out 4 times a month vs. 10. We all know these people!
I mean how many mocha-chinos would it take to bump your payment $200/month?—about 40—so add 1 a day plus a few lunches and a couple splurges at the grocery store and you’ve got literally a ton of money in savings of interest—-and you own the home much much faster.
Kudos on your move! how about this thought exercise—-since rates are a bit lower now (lets just say for arguments sake you could get a 4.5%)—why don’t you go refi back into a 30? I’ll tell you why that causes a bit of stomach churning—it’s risk—no one does the math on risk when they look at the lower payment. If they did, we’d all still be doing refi’s and putting that cash into the stock market, or home improvements, or some other cool investment—-now that folks have been scared straight, that idea doesn’t seem to appealing anymore. They just want to keep their homes—that’s why—imho of course—-the 15 is generically a better deal. More sacrifice, yes, but removes a lot of risk, and saves a ton on interest.
the logic commonly used in these rationalizations is that:
1. they’ll pay the 30 like a 15 (very low likelihood…life happens). 15′s pay off in 15 every single time!
2. They’ll make more money in the stock market or X with the difference in payment. (sounds awesome when a bubble is in effect—not so cool when most every asset class has taken a hit—and no one adds in taxes, inflation or risk..)
2b. since I have a mortgage, I get to write off the interest and save on my tax bill. (you could do the same by giving to charity….and how is paying more interest to save a much smaller amount in taxes sane?—do the math—pay the bank 3-4x what you’d pay otherwise in taxes?—makes no sense)
anyway, the logic is full of holes and is pushed by bankers and realtors—anything to make the sale!!! ;]
you make excellent points. for us the difference from 30 to 15 was $1100. Yes, it was a huge mortgage. In the end, my goal was to have the mortgage end before the kid started college, and we retired.
So I am more conservative than those who would refi now to 30 years to bet they’d beat the rate with their investments.
For us the $1100 was saved for retirement and put into a (matched) 401(k) account, so market return notwithstanding, we are far ahead.
Yikes!—yeah at that end of the spectrum, it’s more than a $200 difference! Average mortgage holder (say about $200k) the difference is a few hundred bucks.
You are also outside the norm by actually investing the difference!—most folks say they will but don’t—or they pull it out at the wrong time.
If you had 15 years though of investing your full house payment, I wonder how much of a difference it would be in the end? you’d also have to put a figure on 15 years of risk to compare them.
The big unknown of course is that if you were in year 16 right now and lost your job—how do you do that math! again, more risk. I’d rather sacrifice more today and reduce my exposure—especially in today’s economy!
Joe and Eric: man, I’m really loving this discussion you guys are having. Keep it up! Great stuff! (Oh, and I’d love to have you as beta testers for my eBook… just sayin’
)
I’m close to a conclusion, but -
Eric – at $200K, 6% 30yr = $1199, 15yr = $1687, $488 diff. Drop rate on 15yr by 1/2% and it’s $1634, still $435.
Everything you say is correct. Until one knows the client, the decision can’t be made in a vacuum. Is that extra $435 going to get matched in a 401(k) or spent on big TVs?
My own situation, we were planning a child, and figuring we’d have a cost for a nanny, so our 30yr decision also took the extra cash flow we’d need for about 5 years that we’d have the nanny.
To the “lose your job in year 16″ question, I’d say I prefer to have the money in investments and still have a mortgage, as the mortgage is only one bill of many.
The “take the 30 and invest” approach does introduce some risk, I suppose, but consider that at 6%, 4.5% after tax, is that such a high risk? Go back 15 years and I think that with dividends the strategy worked. (The return was an average 7.9%/yr in dividends and cap gains, or 6.74% after taxes, not huge, but this period included the 2000′s a horrible decade.)
This discussion has progressed a while since I last posted. Thanks for all the thoughtful posts.
Eric you talk about the security of paying off the mortgage, and I can sympathize with that goal, but I think joe makes a good point; that there are other bills to pay in the event of a job loss, and having money in the bank, instead of in the house, helps pay those bills.
One thing that I would like to add to this discussion, is whether or not you live in a non-recourse state. I live in Idaho, which is essentially a non-recourse state, meaning that if you default on your mortgage, the bank cannot collect on your investments, and they only get the house back.
Consequently, in my state, there is less risk having more money in investments than in the house because if there is a job loss, you can walk away from the house, and still keep your investments.
Setting aside the moral debate about strategic default, i think you have more options and flexibility to reduce risk if you live in a non recourse state with a 30 year loan.
@ Joe…yeah big TVs…my money is on Best Buy! ;] and yes of course no vacuum’s here, but MOST Americans for better or worse have little to no discipline, so I always skew towards the dummy-proof approach!
And the risk I’m referring to is ‘no mortgage’ vs. ‘having to make the call on selling the house’ IF you lost your job in year 16. The math looks good on the surface, but if you’re not wanting to move your kids, the hassle factor of selling/finding somewhere new etc.—to me that is a risk with a very large price tag on it. You’d have your ROTHs or whatever, but you’d potentially be renting again!
@ Dan—yes non-recourse would be an awesome option, though as you mention, most states don’t provide that. (mine doesn’t)
And I think walking away from a house (aka your home!), is a MUCH tougher deal than we’re acknowledging. Yes, the math is the driver, but there is a huge price to pay for your family and just plain old hassle in selling your home.
My contention is that most American’s DON’T have that money in the bank to pay their other bills. They’d be forced to go down the list—cable, gone, extra cell phones, gone, eating out, gone etc. etc. and at some point they’d cash out their investments to save the house (or not)—either way I think that ‘extra’ money in the 30 vs 15 model is not really sitting there—it has been spent.
I know the math makes it seem safer, but like I said—in year 16 on a 30—IF you lost your job, it won’t seem that safe.
You know that kind of reminds me of Dave Ramsey’s debt snowball technique in the sense that Dave admits the math doesn’t quite work out best, but based on the financial behavior of most people it is better to pay off the smallest debt first rather than the highest interest because it is a motivator that keeps people focused.
So for most people, the self imposed discipline of the 15 year note is preferable, because it is just too tempting to spend the extra couple of hundred bucks on consumption–rather than investment.
So perhaps this depends on your level of self discipline, as well. And it comes down to a personal assessment of how best will you stay discplined with your finances.
I think my wife would be better served with the 15 year note
@ aspiration
In the context of investing instead of paying off your mortgage, inflation isn’t quite simply subtracted from the growth rate because if you are investing instead of paying of your mortgage, you get to pay the bank back with inflated dollars.
True…Dave has human behavior dialed in—-people always focus on the “finance” but never the “personal” part of it!
On the other hand, some people enjoy investing and saving. I guess if you get some emotional satisfication out of a penny saved is a penny earned, then maybe the 30 year note is the better choice.
True, but I’m guessing that’s 1 out of a 100 Americans. Seriously.
if we’re suggesting a set of best-practices here, I still feel the 15 is the no-brainer for those 99 other Americans.
Sorry eric, if you’re going to make up a statistic, as I often do, it needs to have some logical backing.
In my $200K example above, the 30 yr payment is ~ $1200/mo, $14,400/yr. If that buyer is using 25% of income, they are grossing $57,600. The difference to 15 yrs including the rate drop, is $435/mo or $5220/yr, nearly 10% of their gross pay.
If you were to look at the average budget, by percent, pie chart style, you’d find that even starting with that 25% mortgage, not too high, most people are not likely to have 10% available, and if they did, there are other choices, not for better return, per se, but other things. An emergency fund, decorating (let’s not kid ourselves what it costs to furnish a new house) etc.
The house, if not brand new, can have expensive repairs, and needing to use a charge card because the budget is too tight makes little sense. On the other hand from my own story, paying early is always an option when money frees up. If you said “more than half” I’d have not commented again. 99, sorry, no.
I would suggest that they should have done that math *before* they bought the house!—and $300-400/month while a lot is not the end of the world for most household budgets. Yes, if you have no other room in your budget to handle “life happening” it’s just a matter of time till something’s gotta give!
Sure 99% is too high, but even on this blog, I’d bet you the number is far over 50%. People rationalize their risk all the time and while they say they’re going to pay extra on the mortgage–they also say they’re going to use that gym membership all year too! ;]
eric – I am in an odd position.
I’d say that if people followed your advice, we would not be in the situation we are in right now. The self-destructing ARMs and subprime mortgages would not have existed if you had your way.
I do know that the median household income is $50K (2007 census). When you look at that number and combine it with the sorry state of savings, you’d have to see that the median family doesn’t have that extra 10% play in their budget (400/mo = 5K/yr = 10% of their income) and that if they did, it would take 5 years of saving it to achieve the recommended 6 mo emergency fund.
(But you are bright and will come back with, “Joe – that’s the problem, people are not budgeting right, whatever mortgage payment you agree to budget for JoeMedian, make that the payment on a 15 yr mortgage, and buy that house, that’s what he can afford.)
A brilliant insight, eric, and one I certainly can’t argue with, we just need a bit of a paradigm shift to get people to think that way and not overreach on their home buying decisions.
True that…if we can’t get that point across today, given the chaos/pain out there, boy..not sure we ever can!! Maybe the days of the McMansion are over?—-I do know that people will always think they can out-earn their stupid decisions!…that’s why I skew towards the conservative option. Good luck!….I know you’ll do fine because you’re paying attention. Readers of this kind of content…they’re not the issue!
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