For many people, owning their own home, as opposed to renting and paying someone else’s bond, is a dream come true. And the dream usually starts as soon as your broker hands you the keys— you suddenly have more room, greater privacy, and in our case, a spacious backyard where my wife and I can chase each other around half-naked.
The joy of homeownership, however, if you don’t really own your home outright, comes at the cost of paying the mortgage, which could take 15, 30, or even a lifetime to pay off for some people… Yikes!
Here are three reasons why you should avoid the standard 30-year fixed-rate mortgage as much as possible.
It will absolutely cost you more
Many people favor longer loans because of the fear of not being able to afford the monthly payments. But it’s the same fear that banks are trying to take advantage of you to maximize profits.
|Home Price||Loan Amount||15-Year Monthly Payment at 4%||30-Year Monthly Payment at 4.5%|
What lenders don’t want you to know is that they make more money off larger and longer-term loans because they can charge a higher mortgage interest rate for the duration of the loan.
Sure, you’ll enjoy the peace of mind of having a lower payment. But that peace of mind comes at the cost of paying twice as much interest compared to a 15-year one!
You’ll build equity much slower
Let’s say you took out a 30-year mortgage on a $200K loan and have been making the payments. Fast forward 10 years, your balance is around $160K— you’ve paid over $120K but only knocked less than $40K off the loan. This means you’ve paid the bank over $80K in interest while building only half of that as your equity.
If you took out a 15-year mortgage instead, your $200K loan would have been paid down to $80K. That’s because you’re making bigger payments on a 15-year mortgage, you pay down the interest a lot faster, which means more of your payment goes to the principal every month.
Having at least 20% of home equity is important because you can avoid paying a PMI (private mortgage insurance), which typically costs between 0.5% to 1% of the entire loan amount on an annual basis.
And it also helps you leave the closing table with a profit should you decide to sell your home in the future.
You’ll end up trying to pay it off sooner anyway
Just imagine being obligated to pay $1,000, $2,000 or $3,000 a month (including escrow for property taxes and insurance) for 30 long years. That’s too long bondage if you will ask me.
As your income grows and your budget becomes more solid, chances are, you’ll get tired of making those payments to the bank. Sooner or later, you’ll find yourself refinancing to a 15-year when the interest rate environment becomes more favorable. Either that or you’d be making extra payments every month— the next best thing to do.
Think about it; the monthly payment of a 15-year $200K loan is higher only by a few hundred dollars. Why not structure the loan in your favor at the outset?
The coronavirus prompted us to pay off our mortgage
I recently paid off our mortgage. As horrible as the virus outbreak is, the panic on Wall Street triggered a stop-loss order against my Bank of America (BAC) stocks that quintupled in value.
Sure, I will have to pay long-term capital gains taxes. But I’m glad that I had accumulated enough cash to pay off the mortgage ahead of schedule.
The payoff has lowered our monthly expenses by 40%.
Since our investments are now over 25 times our annual expenses, in many people’s books, we are considered financially independent!