Mortgage Straight Talk - Choosing a 15-yr or 30-yr term

HI EVERYONE!!! I’m Ashley, and I’ve been looking so forward to sharing this first post with you guys. This is a topic that is near and dear to my heart and it's a little bit long (in true soapbox fashion). But I promise it'll be worth it!

Here’s the scenario: Think back to your experience buying your first house, maybe even your second or third house. At any point during your purchasing experience, did the mortgage consultant or sales rep really give you the full picture of a 15-yr vs a 30-yr loan? OR give you the tools to make the analysis yourself? Chances are you, like most Americans embarking on purchasing their first or second home, never heard the difference between the two aside from the monthly bottom line, let alone the myriad reasons why one might be better for you than the other.

And that, my friends, burns my biscuits.

If you’ve heard much about them at all, you’ve probably heard the common wisdom that you can keep your payments flexible and lower by choosing a 30-yr and making extra principal payments each month to pay it off in 15 years. And if you’re planning on staying in the house for more than 10 years and having payment flexibility is a concern in your budget, this is a rock solid plan. HOWEVER, there are two big caveats that keep this from working for the majority of the population:

•        The average length of time homeowners stay in one house now is only 5-8 years, and
•        It takes a lot of discipline to keep ignoring the calls of life redirecting your extra cash to the mortgage when it isn’t required on the bill. You know what calls I mean.... We are waaaay to good at justifying purchases to ourselves, especially when it’s something for the household and not directly for us. That shiny new TV was for the family, not us, right? RIGHT? 

So what considerations do you really need to keep in mind when deciding if a 30-yr or 15-yr is right for you? I’m glad you asked! The following checklist assumes 100% financing since it’s the most common loan for first time homebuyers.

A 30-yr mortgage is probably right for you if:

• You can only afford the payment on a 30-yr for the loan amount you’re seeking.
• You plan to stay in the house for at least 10 years (even better if you can make the extra principal payments)
• You plan to invest the payment difference responsibly in retirement or other funds that will yield growth at least relative to the difference in the interest payments
• POSSIBLY for the income tax reduction. See the notes on Taxes below to help you weigh the impact of the added deduction.

A 15-yr mortgage is probably right for you if:

• You can afford the difference in payment easily – then take the 15 hands down. No contest!
• You only plan to be in the house 5-7 years. Even if you think there’s a chance you’ll have to put your house back on the market in that time. See the chart below for the evidence as to why a 15-yr knocks a 30-yr out of the water in the short term.
• You are close to retirement and foresee a need to reduce living expenses. Home equity lines of credit can be powerful financial tools in the case of emergency or illness, but they require equity.
• The interest rates are higher. When the rates go up, the benefit of a 15-yr over a 30 really explodes.

Taxes (AKA, payin’ the Man):

I’ve had the conversation with many friends who were convinced that they needed the higher interest for the income tax deduction come April 15^th.  After we did the math, that only turned out to be true for about half of them. If the higher interest will reduce your taxable income enough to lower your tax bracket, then this is probably a strong consideration for you. If not, you can estimate the value of the higher deduction to your tax savings as:

(Taxable Income2 x Tax Rate) – (Taxable Income1 x Tax Rate) = Tax Savings

In other words, if you make $75,000 a year in a 25% tax bracket with anticipated itemized deductions of $13,500 with a 30-yr loan or $12,000 with a 15-yr loan, your tax savings for paying $1,500 more a year in interest is only $375. Surprising, eh? And not in the awesome finding-money-in-the-laundry kind of way, either.

The Really Real Numbers - Finally!

WHEW! Time for a breather! If you’ve hung with me this long – you are a rock star. Finances are never fun reading, but our home is the biggest asset most of us have, so knowing how to get the most out of it is crucial to our family’s financial well-being. So, if you’re the finance-savvy rock star I think you are – this next part is for you! To play with the numbers and make them match your circumstances, download the full amortization schedules here for each of the scenarios demonstrated below.

Below is a summary of what to expect from the first 5 years of 3 different $150K mortgages:

• A standard 30-yr loan with no extra payments
• A 30-yr loan with extra principal payments (the total additional payment is the average of the principal payment cost over the 5 years)
• A standard 15-yr loan with no extra payments

The loans use the current rates listed on a national bank site as of 10/23/2015 and assume 0% down payments with a start date of Jan 1, 2016. Total Escrow (insurance/property taxes) + PMI has been estimated at $245. 

Terms: *Equity Earned = Original Loan amount less the Principal Balance After 5 Years

**Net Gain = Equity Earned less Total Interest Paid. Interest Paid represents the cost of the loan. The goal is to minimize the cost of the loan while maximizing Equity Earned.

Still hanging in there with me? Then you probably just noticed that Option A left you in not much better shape than having paid rent for 5 years. Granted, your sales price may be higher than what you paid 5 years ago, but in this buyer's market there are no guarantees. Then you get to add in the cost of any repairs you'll be required to do (that can include appliance and carpet replacement, roof repairs, costly structural issues, etc), the 6% broker's fee, and the other closing costs sellers are expected to pay in markets like we're in now. Even after paying down your mortgage nearly $15,000 in 5 years, you could still end up paying out of pocket to sell your house. And I can promise you that it really does happen. In fact, it happened to me just a few years ago. 

That was when I vowed that "With God as my witness, I will never go [uninformed] again!" And hopefully I can also use these experiences to help others make the best decision for them along the way.

Thanks for sticking out my first post with me, friends! I promise the next post will be more light-hearted ;-)  In the meantime, don't forget to download the amortization schedules tool for your own use!