Why a 15 Year Mortgage Isn’t Always the Best Choice

By

With mortgage rates being at all-time lows many homeowners are looking to take the rate bonanza a step further by going for a 15 year mortgage. Not only will you pay off the mortgage in half the time, but you’ll get an even lower rate for doing it.

Sounds like a good deal right? Not necessarily, and certainly not for everyone.

15 Yr vs 30 Yr Mortgage

Payment Shock With A 15 Yr Mortgage

Right now, you can get a 30 year fixed rate loan for around 3.25%. You can also get a 15 year fixed rate for just 2.75%. As far as rates are concerned, comparing the two is the perverbal “no brainer”, right?

No so fast.

In a pure mathematical sense, rates matter a lot. But real life and math equations are two very different things. In the real world, rates matter mainly as a tool in reducing a monthly payment. But in this comparison—the lower rate of the 15 year mortgage will not reduce the payment.

No matter what the rates are on either loan type, the payment on the 15 year loan will always be higher than it is on the 30 year loan.

If your mortgage balance is $200,000, and you refinance to a 15 year loan at 2.75%, the monthly payment will be $1,357 per month. If you refinance the same loan amount for 30 years at 3.25%, the monthly will be only $870. That’s a difference of $487 per month! How does an annual rate savings of .50% look against a monthly payment that’s nearly $500 higher?

Put another way, the payment on the 15 year loan is more than 50% higher than it is for the 30 year. You’d have to think long and hard about whether or not that’s an advantage. For most people, it will be more of a nightmare.

No Immediate Benefit From A 15 Year Mortgage

This is another point that I don’t think most borrowers fully appreciate. While it’s true that you’ll pay off a 15 year mortgage in half the time that you will a 30, there will be no immediate benefit for doing so.

You will have to make the higher monthly payment for 15 years—that’s 180 monthly payments—before you’ll see the fruits of your labor.

When you sign up for a 15 year mortgage, you lock in the higher payments for the entire length of the loan. The payment will remain fixed for the entire term. Yes, you will be paying your mortgage off much sooner, but the day-to-day cost will be substantial.

With 15 year mortgages, virtually all of the benefit of the loan comes at the very end, when the house is owned free and clear.

There’s No Turning Back

Along the same line, once you take on a 15 year loan, you’re locked into for the duration. Yes, it will pay your mortgage off sooner, but if you lose your job or face some other financial disaster while the loan is still outstanding, the higher payment will sting.

You won’t be able to call up your lender and say “we made a mistake, can we go back to the 30 year loan?” Yes, you can refinance, but if you have no job or your credit has deteriorated since closing on the loan, you may not qualify for a new one.

15 years is a very long time when you’re making a high payment.

The Disappearing Income Tax Deduction

One of the biggest benefits of having a mortgage is that it’s one of the last solid tax deductions available to the average taxpayer. Medical deductions are reduced by 7.5% of your adjusted gross income, and credit card- and auto loan-interest aren’t deductible at all. But mortgage interest remains fully deductible. That can be a substantial tax savings, especially for high income taxpayers.

But since a 15 year mortgage pays off quicker than 30 year loan, they also make the tax break go away sooner. It’s not just the loan balance that goes away—the tax deduction goes with it.

Neglecting Other Financial Needs

When it comes to 15 years mortgages, there’s a definite opportunity cost. In the example above of the payment difference on a $200,000 mortgage, the payment on the 15 year loan was higher by $487 per month. That’s almost $6,000 per year!

That begs the question: what else could you be doing with $6,000 each year?

How about paying off a car loan, paying off credit cards, funding a Traditional IRA or Roth IRA, building up emergency savings, funding college plans for your children, or retiring student loan debt?

All of these are at least as worthy as paying off your mortgage early, and most of them will be more immediate in their impact. $6,000 per year could be putting out a lot of financial fires and/or funding a lot of accounts. By loading all of it onto a single venture—paying off your mortgage in half the time, you deny yourself access to the money to do other things.

That’s opportunity cost, and it’s a factor with a 15 year mortgage.

photo credit: Freedigitalphotos.net

Which Debt Should You Pay Off First? It’s NOT What You Think

By

Nearly everyone on the web and in the financial press is telling us to get out of debt. Get out so you can save more, so you can retire early, so you can improve your credit score, so you can just get out of debt. But what if you have several debts—credit cards, a car loan, an installment loan (or two), a student loan and a mortgage. Which debt should you pay off first? Or does it even matter?

I think it does, in fact, I think it matters a whole lot. Some loans are just more…dangerous…than other loans, and need to be paid off sooner. This is especially true if you’re struggling financially. You should make a priority to pay off the loans that have the greatest potential to cause you the greatest problems in the event you can’t pay them any longer.

What Debt Pay First

Which Debt To Pay First?

Here’s my attempt at establishing that priority, and the reasons why for each. Feel free to disagree!

1. Car Loans

Most people start paying off debt with their credit cards, but I disagree. A car loan is a secured loan, which means that if you stop making the payments for any reason the car will be repossessed by the lender. If you hit on hard times and can’t pay your bills, the last thing you need to have happen is to have your car taken away.

You need your car to commute to your job, to run your business and to live your life. If it’s gone, you’re ability to pay your other debts will be gone with it.

Maybe this is just my thinking, but a car loan is really the most “strategic debt” that you have. A debt chain reaction will be set off if you lose your car, one that you may not be able to recover from any time soon. Get your car free and clear as soon as you can, then you’ll have time to deal with other debts.

2. Other Secured Loans

These loans could be debts taken to buy furniture, household appliances or to replace major components of your home, like a furnace or central air conditioner. And like a car loan, they’re secured and that’s why you want to pay them off ahead of unsecured debts. If you fail to make your payments for any reason, the lender will be able to take the collateral from you.

That may not be a problem if the collateral is furniture or a boat—you can live without those. But if it’s your computer that you use for business, or your air conditioner in the summer time, life will get ugly in a hurry.

These are worthy of being paid off right behind your car loan.

3. Student Loans

This is a sticky subject. Because they tend to be large and generally carry low interest rates, most people prefer to leave them alone and take every one of the ten, 15 or 20 years they have to pay them. But that’s not always the best course of action.

Though we may not think of it this way, it is a reality that student loans are unsecured debt. Even though they’re typically the size of car loans or even larger, there’s no asset beneath them that can be sold to pay them off if you get into financial trouble. Worse, they can’t be discharged in bankruptcy. In fact, except under certain very limited circumstances, you can’t settle them with the lenders in the way you might be able to with credit cards. For that reason, paying off your student loans deserves a higher priority than for credit cards.

4. Credit Cards

This is everyone’s favorite payoff! And why not? Credit cards are really annoying, at least when it comes time to pay them! But at the same time they’re aren’t as threatening as any of the above loans if you can’t pay them.

Sure, credit card lenders have remedies they can pursue against you, like nuking your credit, torturing you with collection calls, charging default interest rates and implementing judgments and garnishments. But they can’t take away your livelihood or kick you out of your home—that lowers them in the pay off hierarchy.

Usually, you can also settle your credit card accounts for less than what you owe, and there are even agencies—some of them non-profits—who will help you arrange this. In addition, though lenders can seek legal remedies against you, they often avoid going too far lest they push you into bankruptcy protection. Credit card lenders don’t do very well when that happens.

The popular “debt snowball” method really is the best if you have multiple credit cards. Pay off the smallest one first, then work your way up to the bigger ones. Each little one you pay frees up more money to pay off the bigger ones.

5. Mortgages

The reason for putting mortgages in last place? It’s typically your biggest debt and it will take many years to pay it off early. Also, even when you start paying it off, your mortgage won’t go away any time soon. Your house payment will remain fixed until the mortgage is completely paid off, as in zero balance. Since that will take many years to accomplish, the mortgage should be a low priority.

[Is it better to rent or own a home? <–What do you think?]

A couple of other things to consider in connection with a mortgage, one being that the payment is paying for something tangible—the use of your home. You’d have a rent payment if you didn’t own your home, so it’s not like the mortgage payment is something extra or extravagant. There’s also the tax benefit of having a mortgage. Since you get a break on your income taxes as a result of having your mortgage, paying it off should be less urgent than paying off debt that has no tax advantage.

Finally, if you plan on selling your home in the foreseeable future, there’s probably no point in working to pay down the mortgage. It will be paid off when you sell the house.

Is this debt pay off priority a bit unconventional? Probably. But when it comes to personal finance, I think it’s always worth looking at things from outside the box.

What to you think the priority should be when it comes to paying off debt?

photo credit: Freedigitalphotos.net

What Is Private Mortgage Insurance, And Is It Really Worth It?

By

When I was a kid, one of the things that I remember about home ownership is that people would have to save up for a long period of time in order to be able to put down at least 20% of the purchase price of the home as a down payment. However, over the past 10-15 years, the practice of planning a home purchase based on when you could save up a 20% down payment has essentially become obsolete.

What Is Private Mortgage Insurance (PMI)?

Because of this failure to come up with the standard down payment, more and more people began paying private mortgage insurance premiums during the real estate boom of the mid 2000s. Private mortgage insurance (or PMI) is insurance that is in place to ensure that mortgage lenders do not lose money in the case where a mortgagor is not able to repay the loan, and the full costs cannot be recovered even after a foreclosure and sale of the property.

Because of this, private mortgage insurance is usually required when the borrower is putting up less than 20% of the purchase price or appraised value of the home. The cost of your insurance will vary depending on the size of the down payment and the loan and the location of the property (like one of these retirement havens), but they typically amount to about one-half of 1 percent of the loan – which would be about $2000 a year on a $400,000 house.

PMI definitely makes sense from the lender’s perspective, since they are taking on more risk by extending a loan that is at or close to the value of the property. In some cases you will actually pay an upfront premium in addition to the ones baked into your mortgage payments.

PMI is an extra fee that can add a substantial amount to your monthly mortgage payment (especially when you consider interest, homeowner’s insurance, and taxes), and you may be required to pay this amount until the equity you have in your home reaches the twenty percent threshold.

How To Stop Paying Private Mortgage Insurance:

If you currently owe less than 80% of the value of your home and are still paying PMI, contact your mortgage company immediately for instant savings (it issupposed to be canceled automatically once you owe less than 78%). They will require proof that your equity position is stable and is more than 20%.

That “proof” will come in the form of an independent appraisal. Unfortunately, you are usually not given a choice regarding the appraiser or the total amount of the fee; but at least you get to pay for it (sometimes at a cost of $500 or more)!

If you still owe more than 80% of the value of your home, but you have enough money in savings (“enough” is relative), it may make sense to pay down your mortgage in order to stop paying these fees.

My Thoughts About PMI

Waste Money

To me, it doesn’t make sense to pay insurance premiums for a plan that doesn’t even cover me . I wonder how many people actually add PMI to the equation when figuring out if it’s time to buy a home. What was that? Most people don’t make any calculations when trying to buy a home? Well, then I guess they won’t mind paying an extra couple of hundred dollars (with the home prices in my state) per month in order to grab a piece of the “American dream”. Maybe you can buy a home overseas instead! 😉

Seriously, how many other types of insurance can you think of where the one paying the premium doesn’t benefit at all from the protection offered by the coverage? And to me, if a loved one benefits, then I benefit, so you can’t add any types of life insurance to that list.

If you have crunched the numbers and you can tell me that it is better for you financially to rush into buying a home with little to no down payment and paying PMI, then maybe there may be some merit to this; but as far as I can see it (in most cases that I have observed), it is a huge waste of money, and it is another cost of being financially unprepared and undisciplined!

Photo credit: Freedigitalphotos.net