Many prospective home buyers just consider the monthly payment when it comes to mortgages. Reasonably so, given the average American’s weekly budget is mostly unaffected by the cost of a home’s acquisition. The final result must be a payment that you can make in addition to all of your other costs.
However, there is a second, equally significant bottom line associated with mortgages: the total sum of money you will pay over the course of the loan (principle plus interest). Logically speaking, it seems reasonable that if you owe money for a longer period of time, you’ll pay more in interest fees. But let’s consider how much more specifically.
At the end of August, the median cost of existing homes in the United States was about $187,000. Let’s say you take out a 30-year loan for that sum at 3.5 percent. The amount you’ll pay each month is $840. You will have paid back the $187,000 plus the $115,297 in interest fees over the course of the 30 years, totaling $302,297.
Your monthly payment rises to $1,337 if you simply take for a 15-year loan for the same amount at the same interest rate. However, the total interest you will pay on the loan is only $53,629 in total! Your total repayment is now $240,629 instead. You just cut out a massive 180 monthly payments and saved $61,668.
These figures as well as the fact that cutting the loan’s duration in half does not need making twice as many payments (in this instance, an increase of around 37%) astound many people. Consider your ability to afford the larger payment while looking for a mortgage. Remember that your income ought to be a little bit more than it is currently in five years. And even higher in ten years. To get out of debt faster, you can even think about purchasing a home at a reduced price.
An important additional benefit of 15-year mortgages is a lower interest rate. The interest rates on 15-year loans are typically at least 0.5 percentage points lower than those on 30-year loans. A 15-year mortgage currently has a rate of about 2.85 percent. This results in even more savings during the loan’s term. A $187,000 loan would have a 15-year payment of just $1,278 at that rate. And the final loan balance is $230,029 in total. Could you afford to pay an additional $438 each month to save over $72,000?
What drawbacks are there to 15-year mortgages?
The greater cost is the only real drawback. It’s legitimate to worry if you might go through a time of unemployment during the next 15 years given our unstable economy. What happens if you lose your job after getting a 15-year loan?
The best option may be to get a 30-year loan and make a personal commitment to the bigger payment even if you don’t feel comfortable committing yourself to a higher one. Make sure your lender won’t charge you a prepayment penalty before you do this. Then, set it up as an automated payment from your bank to assist you stay to the greater amount each month. Make sure the additional payments go toward the principle. You might need to add that information to each payment.
The disadvantage of this kind of prepayment plan is that you miss out on the opportunity to benefit from the lower interest rate. The benefit is that you always have the choice to return to the lesser payment if you run into financial trouble during the loan’s term, freeing up cash for your other obligations.
What about more modest additional payments?
Any more money you can afford to put toward the principle will lessen your overall obligation and cut the length of your loan. In our 30-year example, adding $245 a month will shorten the loan’s term by 10 years and bring the total amount of interest paid down to $73,266. You avoid paying for 10 years and over $42,000.
The benefits of accelerated payments simply cannot be emphasized, even in the setting of historically low interest rates. You need not accept permanent debt as a way of life, despite the fact that it is typical in our society.
