Sticking with housing for a bit, I wanted to highlight an underused and under-sung borrowing option: the 15 year mortgage. Yup, it does it exist, largely sitting in the toolbox, enviously glaring at its 30 year cousin, desperate to see some action. In this post I wanted to highlight some of its benefits and drawbacks so homeowners have a better idea of what’s out there.
First of all, obviously when financing something—anything really—the longer the term the easier the payments. As Americans have become less adept at deferring consumption over the last several decades the terms (i.e., the length) of our loans have extended in lock step. One obvious example of this is the fact that people now often finance a car purchase over 5, 6, or even 7 years. You’ll often notice 6 or 7 year offers now when watching a tv commercial. These loan terms were relatively unheard of just a decade or two ago.
While extending the loans in this way makes it easier to afford the payments (obviously), it has the under-appreciated side effect of making everything more expensive. While people will go to great lengths to secure the best absolute deal on the price of a car, without flinching they’ll sign up for the 6-7 year loan, which will often cost them ~$1000 or more than if they stuck with a 4 year deal (and that's for a cheap car when interest rates are low). Check out this calculator to find what your car is really costing you ('hit show amortization table'). At the rate people change cars these days (and at the rate that they depreciate), who imagines themselves wanting to be paying on a car for 6 years anyway?
On to the housing part of the equation. Yes, obviously, a 15 year mortgage will lead to a higher monthly payment, but have you ever figured out how much it might save you? You may be surprised. Let’s quickly walk through it. Using this calculator and starting with a 30 yr mortgage (using a $200k mortgage and a 4.08% rate; hit ‘show amortization table’), the interest costs add up to ~$147,000. That’s just in interest. If one instead gets a 15 year mortgage with a rate of 3.38% (these are current national averages), the same $200k mortgage would cost you only ~$55,000 in interest, which is a savings of around $92,000 over the loan’s lifetime. If we average it out over the longer 30 year period, that’s a savings of roughly $3000 per year. Not exactly chump change. Yup, the monthly payment goes from $964 to $1418 per month, but if one simply waited a couple years to save up a larger down payment and pay off other debts, it’s not that unreasonable of a jump.
An additional benefit of the 15 year mortgage is that you pay down your principle faster, ensuring you don’t go underwater (during falling house prices) and end up with the problems detailed here. A significant advantage of the 15 year comes with its lower interest rate, which is why the monthly payments aren’t that different. Most of the savings in terms of interest, however, come from the fact that you’re simply holding the debt for a much shorter period. Despite the general belief that buying a house is a necessary part of building wealth, let’s face it—debt is expensive. If you’re patient and defer your purchase until the terms are more favorable, you can save yourself, oh, almost $100k.