The Art of the Small Mortgage
If you’re under 25, avert your eyes, for here there be mortgage talk.
As the proud renter of a 500-square-foot studio, I’ve been watching the housing market’s impending bubble burst with keen interest. The lending community has become quite creative with new products, designed to let people own things they can’t afford. For instance, you can now get a 50-year mortgage, or even an interest-only mortgage. These can make sense in certain circumstances, for tax reasons, since mortgage interest is tax deductible - you could take an all interest loan, invest the difference elsewhere, and pay taxes on the principal at the lower capital gains rate. But for most people, that’s not gonna happen.
So I was thinking, if the 30-year fixed rate mortgage is the gold standard, what happens if you pay off a little quicker? Here’s the monthly payments and total costs of a 400,000 mortgage at 6%, for 15, 25, 30, and for a laugh, the 50:
|
Number of Years
|
15
|
25
|
30
|
50
|
|
Monthly Payment
|
$3,375
|
2,577
|
2,398
|
2,106
|
|
Total Interest
|
$207,577
|
373,163
|
463,352
|
1,263,600
|
The key point, of course, is that the 15 isn’t anywhere near twice the payment of the 30. Due to the magic forces of compound interest, it’s only about 30 percent more. And the dreaded 50-year will only save you $200 a month in the short term, but you’ll pay more than a million for the credit. And of course, interest rates are typically higher for these brilliant schemes, so 6% is probably out of the question. Unless you’ve got an alternate investment plan for the difference in payments, and you’re very disciplined, picking the shortest mortgage saves a huge amount of money.
Is a 15-year mortgage reasonable for a first-time buyer? If you don’t mind paying top dollar for a shack, I suppose it could work. (or you could buy cheap land and get a Tumbleweed house) But the 25 is pretty enticing. The moral: A little smaller means a lot cheaper.
April 2nd, 2007 at 12:16 pm
So, I’m not sure I entirely agree. If I were planning on living in the same house for a long time (more than 15 years?) it might make sense to lower lifetime payments. But for many people, who don’t plan to live in their homes for much more than 5 years, you end up losing money by paying faster.
If I put 10% down on a $500k house, the house goes up in value 3% per year, and I sell in 5 years, the house will sell for about $580k. This means that my $50k investment yielded an $80K profit. 160% - not too bad.
No matter how much you put down, the value of the home increases by the same amount - $80k. However, as you put down more money, your rate of return decreases. The same thing happens when you pay down your principal faster.
So, if the house value increases at 3% per year, every additional dollar of principal you pay back is increasing at only 3% per year. That’s lower than what I could get from my conservative investment portfolio (about 8%).
April 3rd, 2007 at 8:29 am
Yeah, but doesn’t that all assume appreciation over the first 5 years? Over the next five, that might not be the case.
April 3rd, 2007 at 10:16 am
Not necessarily - the more money you put down, the more you can lose if the market dips. The biggest risk, I think, would be if after 5 years you either couldn’t afford to sell or decided that you didn’t really want to move out. Also, while it’s not a very diverse investment (and therefore risky) many people use home ownership as their primary vehicle for savings.
April 19th, 2007 at 1:45 am
Short Term Rentals…
Some portions of this article sounds interesting. May be you have some links where I could read more about this topic?…