This is a guest article by Laura, a twenty-something woman working to improve her finances and reduce debt. She writes about personal finance for college students and grads at Green Panda Treehouse.
We’re buying a town house and it has a been a huge learning process. We have been running the numbers and making sure everything works budget wise. While looking through some books and blogs, I noticed some people mention getting a 15 year fixed rate mortgage instead of a 30 year fixed rate mortgage.
Talking with friends and family, many of them advocate getting a 30 year mortgage and paying it off in 15 years. Their reasoning is this gives you some flexibility. I wanted to run the numbers and see if this is a viable solution.
How much money you can save with a 15-year mortgage
Many people may not realize the financial upside of having a fixed 15-year mortgage. Besides paying less total interest, they typically have lower interest rates than 30-year fixed mortgages. Most of your money in the beginning of your mortgage payments goes to interest. As you move further and further along, more and more of your money goes towards principal.
Comparing a $200,000 fixed-rate mortgage for 30 years at 5.25% and a mortgage for 15 years at 5%, you get the following results:
You save a total of $112,901.39 in interest going with the 15-year fixed mortgage. Could you use that $112,901.39 for something else?
The downside of a 15-year mortgage
The downside for a 15-year mortgage is the same as any other mortgage: affordability. If you can afford a 15-year mortgage comfortably, congratulations. This is a great option for paying less interest over the life of the loan.
If money will be very tight with a 15-year mortgage and you are a bit hesitant with the monthly budget, you have two options:
- Wait until you have enough buffer room in your monthly budget for a 15 year. Save up while you’re waiting and put down a larger down payment.
- Decide to get a 30 year loan and come up with a plan to accelerate your loan.
You also have to weigh the opportunity costs of the money difference. That extra money could be redirected to investing more into the stock market for retirement or some other financial decision.
Will you pay a 30-year fixed mortgage in 15-years?
Dave Ramsey mentions the statistic that more than 97% of people who planned to pay their 30-year mortgage in 15-years do not. He has seen from his personal experience running his program that people lack the will power to keep up regularly with mortgage payments.
Ramit also observes that many people believe that they are the exception to the rule. This can lead some to not prepare properly. You may plan on paying your mortgage in 15 years, but if you rely on pure will power, you can set yourself up for failure.
Why pay off a mortgage sooner?
There are a few reasons why someone wants to pay off their mortgage sooner than 30 years. One popular reason is that they want the “peace of mind” in owning their home outright. If they lost their job, or if they experienced a pay cut, people would feel better knowing they did not have a mortgage hanging over their head.
How to accelerate your mortgage payments yourself
You can accelerate your payments even if you have a 30-year fixed rate mortgage. Automating payments can help you pay off your mortgage sooner and avoid some mental barriers to staying focused on your goal. By not managing the payments personally on a on a monthly basis, you can increase your chances of paying off the mortgage a lot sooner.
- Start by examining your budget line by line. Know exactly what your actual income and expenses are. This will save you time from adjusting payments often as you realize you overestimated what you can put in.
- Have a buffer. If you don’t have a fully funded emergency fund, consider getting that taken care of before accelerating mortgage payments.
- Set up an automated payment plan. You can go through your mortgage company or you can go through your online bill pay. Note: Some mortgage companies offer programs to send extra payments but they cost you some money.
- Start off with an extra payment that leaves you some wiggle room. As you get a raise in your income, increase your accelerated payments little by little. By adjusting it every year or so with your raise, you are accelerating your payments without missing the money.
- Automation is key. You can build your payments up through the years while still having money to invest for retirement, save for other goals, and pay your bills.
This automated system can give you some flexibility in case your income decreases, like a pay cut or lay off. You simply pause or lower your extra payments and put them into your savings account as needed.
Even if you don’t hit the 15 year mark, you will still save tens of thousands of dollars by avoiding more interest payments. Think about it, you’re saving couple of years of salary for less than an hour of work spent on a phone call and online bill payment! I think that’s a great trade off.
Mortgage contact information
If you’re going through your mortgage company, check with them to see if there is a prepayment penalty or any fees associated with the accelerated payments.
- Bank of America: (866) 642-0987
- Chase: (866) 461-5953
- Citi: (800) 283-7918
- MetLife: (888) 638-6964
- Wells Fargo: (866) 234-8271
What about you?
What kind of mortgage do you have? Are you prepaying it? Why or why not? What suggestions do you have? Please also share your experience working with the mortgage company on prepaying your loan.
Updated September 3, 2012 and originally published September 11, 2009. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.