Written by Benny L. Kass
Question: For some time I have been wondering if I should consider getting a fifteen (15) year mortgage, as I do not want to be burdened with a mortgage in addition to condominium fees. Assessing how and when to consider such a change is confusing to me, and I would appreciate your advice on the advantages and disadvantages of the fifteen (15) year versus the thirty (30) year mortgage.
Answer: I must state at the outset that I am biased against the fifteen (15) year loan. While there have been many commentators who have praised what they perceived to be the benefits of a fifteen (15) year mortgage, in my opinion, such a mortgage rarely makes sense for the average homeowner.
Let’s look at some examples. You want to compare a $300,000.00 loan to be amortized on a thirty (30) year basis as compared to a fifteen (15) year basis. Lenders typically will provide a lower interest rate if you take a fifteen (15) year loan rather than the thirty (30) years. So for comparison purposes, let us assume that a 30 year loan is 4 percent and a 15 year loan is 3.5 percent.
To amortize the loan over fifteen (15) years, your monthly payment of principal and interest (P&I) is $2,144..65. On a thirty (30) year basis, the P&I is $1,432.25. As you can see, this is a $712.40 cash savings per month on a thirty (30) year loan. On a yearly basis, this is a savings to you of $8,548.80. That’s a lot of money.
Keep in mind that the interest deductions for tax purposes will, by and large, be the same for the first few years, but as your principal balance goes down faster with the fifteen (15) year amortization, accordingly your interest payments will also be smaller.
Thus, the major benefit of the fifteen (15) year loan is that you will save a lot of interest over the life of your mortgage. You are also putting up, in our example, over $8,500 a year toward principal, thereby reducing your mortgage balance and building up your equity.
Equity is the difference between the market value of your house and the mortgage or mortgages which you owe. In good real estate market conditions, property values increase on a yearly basis as much as ten to fifteen percent. Even in bad times, we all hope that property values will at least keep up with inflation, although obviously there will be dips and decreases in market values on a periodic basis. Many homes impacted by the “mortgage crisis” several years have now rebounded.
And assuming that we anticipate growth over the next decade, the equity in your house will grow regardless of the amount of your mortgage. This equity is “dead equity” and in my opinion, you might as well be taking that extra $8,548.80 and burying it in your back yard. In effect, that is my analogy for the fifteen (15) year mortgage.
I would rather take the extra $8,500.00 a year and invest it somewhere. I could put it in a pension plan, I could invest it in the stock market, I could give it to my children, or I could spend it on a vacation with my family.
After all, what will you do with your house fifteen (15) years from now when your mortgage is paid in full? I know of too many people who are currently house rich and cash poor. When you are in retirement, you may not keep that house, or if you do, you want to make sure that you also have some sort of nest egg to be able to enjoy your retirement years. If you have put all of your money into your house, and then you retire, you may not be in the financial position to tap into that equity at that later date.
The Department of Housing and Urban Development (HUD) has just tightened up the loan requirements for a Reverse Mortgage, so you may not be able to count on that down the road.
Accordingly, in my opinion, take the extra $8,500.00 a year and invest it in a conservative, long-term investment for the next fifteen (15) years. Even without any computation for interest, this will grow in the next fifteen (15) years. That will be the start of this important nest egg for the rainy day.
However, the advice I give is obviously general. You are advised to discuss your specific needs, plans and tax considerations with your own advisors.