When people ask me for my recommendation on purchasing a home, I always start off by recommending one takes out a 15 year mortgage instead of a 30 year mortgage. I’ve written before about the difference in cost between a 15 year and 30 year mortgage. But I thought today I would update that post with numbers from today’s interest rate environment and doing so got me to thinking what you could do with the interest savings from the 15 year mortgage over the 30 year mortgage.
Let’s say you buy a home at the August 2012 median price of $256,900 using the current 30 year fixed mortgage rate of 3.62%. Over the course of the 30 year term you would pay approximately $165K in interest. Now compare it to the current 15 year fixed rate mortgage average rate of 2.91%. You would only pay approximately $60K in interest over the 15 year term. That’s over $100K difference! True, the 15 year mortgage has a higher monthly payment ($1,763) compared to the 30 year mortgage ($1,170) but you will pay off your mortgage 15 years sooner. What would happen if you took that interest saved and invested it for 15 years?
By spreading the $100,000 dollars saved in interest over 15 years, you would be saving around $6,500 a year in investments. If you averaged a 10% rate of return that would leave you with approximately $225,000 in savings at the end of the 15 years. How do you like that 30 year mortgage now?
What can we learn from this calculation? A 30 year mortgage costs you a lot more than a higher interest rate. Yes, they are the standard in the mortgage industry, but why? Because some bank discovered that marketing 30 year mortgages worked because people could buy a lot more house with the lower payment. But after looking at the numbers, can you really “afford” a 30 year mortgage?
How long of a mortgage do you have? 15 year? 20 year? 30 year? Other? What made you decide to go with that length of term and are you happy with your decision?