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:
|
30-Year |
15-Year |
| Monthly Payments: |
$1,104.41 |
$1,581.59 |
| Interest Paid: |
$197,587.59 |
$84,686.20 |
| Total Paid: |
$397,587.59 |
$284,686.19 |
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.
Yesterday I received an email from a Consumerism Commentary reader who has a question about her mortgage refinancing options and is looking for advice. I tend not to offer too much personal advice, but I responded with some thoughts and offered to open up the discussion to other readers. Please read through and see if you have any thoughts for Heather. Please feel free to leave a comment after this post.
Hi. I’m a long-time reader of your blog, occasional commenter, and I thought you might have an opinion. My husband and I are looking for advice.
We paid $319,900 for our house almost four years ago. We put $120,000 down and got a 30-year fixed at 5.875%.
We were looking at refinancing and were offered 5% with one point, making the total loan around $196,000. We anticipated our house currently being worth roughly $220,000. Using the Fannie Mae Refinance Plus Program, since we did not previously pay mortgage insurance, we would not need to again.
Our appraisal just came in at $190,000. If we want the same rate, we’d now need to pay 2.3 points, which would put our loan at roughly $198,700, which is both a much larger up-front cost but more distressing, it immediately puts us upside down.
We’re not sure if this is still a good decision. Do you have any thoughts?
I initially responded to Heather some additional questions to clarify her situation. Here are more details.
Q: Do you intend and reasonably expect to stay in the house or do you think you might sell and move within the next few years?
A: We are reasonably planning to stay in this house. (In my ideal world, we’d move closer to where I work, but in real life, after having lost so much value and sinking $60K into structural repairs, we’re not going anywhere.)
Q: Are the monthly payments unmanageable with your current mortgage?
A: Our monthly expenses are not unmanageable at all. Besides the mortgage, we have one car loan and one student loan, but no other debt. Both of us are teachers, and both of our districts both gave pay cuts and increased copays/deductibles. So while expenses aren’t necessarily going up, our income went down. My husband decreased his 457 contributions, which I didn’t agree with but it was a fight not worth fighting.
Q: How do you intend to use your freed-up cash flow (such as invest, pay other bills that are being neglected, save, etc.) if you don’t mind sharing.
A: At this point, the $120-ish per month that we’d save would really allow us not to cut back as much. I have a few side interests that I’m hoping will turn profitable, but in the short term, I can’t count on that at all. (I’m good with ideas and with doing, but I’m not good at marketing/selling myself. Working on it.)
Also, we gave the nice refi guy $495 to lock the rate and get the ball moving. At least $350 of that is not refundable, as it paid for the appraisal. I don’t know at this point if the remaining $145 is refundable or not.
We need to get him an answer in the next couple of days, as far as I know.
Happy to answer any other questions as wanted/needed.
Do you have any suggestions for Heather? Please feel free to leave your thoughts in the comments.
“Now is a great time to buy.” That has been the advertising mantra of the National Association of Realtors regardless of the state of the housing market. The NAR certainly has a purpose; its mission and vision is clearly displayed on the organization’s website: “The core purpose of the NATIONAL ASSOCIATION OF REALTORS® is to help its members become more profitable and successful.”
The NAR looks out for its due-paying members. Notice that the mission of this non-profit organization is not to help consumers either find bargains when buying a house or to help sellers find the highest bidders. Real estate brokers, particularly those who qualify as Realtors (which according to the organization, should be represented in all uppercase letters, include the registered trademark symbol, and be pronounced in the unnatural American English combination of phonemes “REAL-TORE”) stand to be more “profitable and successful” by increasing the number of transactions they broker.
From what I understand about commissions, a 6% commission is often split between the buying agent and the selling agent, and if the agent is part of a realty company, the 3% is split with the company. A real estate agent holding out for a buyer’s asking price of $250,000 rather than $220,000, a difference of $30,000, stands to increase his income approximately $450. That seems hardly worthwhile if it takes several months before the asking price is met. The $450 is hardly an incentive for the broker; he could do better by closing the deal and moving on. On the other hand, the $28,200 (the $30,000 in price difference minus the 6% paid to the agents) is a significant difference for the seller. This just illustrates that real estate agents have little incentive to work hard for either the seller or the buyer except to create a good relationship in order to foster referrals.
That’s not the point. The point is that the National Association of Realtors’s only goal is to encourage more real estate transactions, and this is why they have been saying that, “Now is a great time to buy,” no matter what’s going on in the world around them. This is also why any data provided to the public by the NAR should be regarded as marketing rather than a true gauge of the economy.
For a well-accepted measure, media generally turn toward the Case-Shiller Price Index (CSPI), measured by Standard & Poors (a company with its own conflicts of interest as well). The CSPI shows that home prices increased for the first time in May. Other positive data include June numbers: new housing starts and existing home sales were both up 3.6% and sales of new homes were up 11%.
Is this a sign that the housing crisis is over? It must mean that there is increased confidence in the ability to find the right price as well as increased availability of loans.
There are some problems, though. Unemployment continues to rise, so consumers may find themselves in financial trouble. That could result in fewer purchases and more mortgage defaults. The increase in purchases may be due to speculators trying to snag deals rather than families moving from apartments to houses. Even if we are at a bottom, the numbers could mean that real estate is leveling without significant increase for some time.
What do you think? Are we headed for a recovery or are there still dark clouds ahead?
Looking for a Housing Recovery, Casey B. Mulligan, New York Times, July 29, 2009.
Yesterday, Consumerism Commentary reader Ryan suggested I write about interest-only mortgages.
There is no such thing as an “interest-only mortgage.” Wouldn’t that be nice, though, to have a mortgage that did not require you to pay any principal back to the lender? Unfortunately, when you become a borrower, your lender will insist upon receiving interest payments as well as principal at some point. What does exist, however, is an interest-only payment option for mortgages. The interest-only payment option can apply to adjustable-rate mortgages and fixed-rate mortgages alike. The purpose is to allow borrowers to reduce monthly payments for a period of time. Rather than a monthly payment of $1,200, in which $600 goes to interest and $600 goes to the principal, the monthly payment would only be $600.
The lower monthly payments during the interest-only period are good for households with irregular income such as commission payments less frequent than monthly, or households with unpredictable income, like that of a business owner who is expecting low income while the business is in a period of growth.
Interest-only payment options also allow borrowers to “afford” a more expensive home. This can be important for an executive who needs to entertain clients at home and its appearance is crucial to career success, but there could be a strong desire to use the lower payments to buy a home beyond the means of the borrower.
This is a dangerous prospect, especially in an environment where we can’t be sure whether the value of the house will rise in the short term. While making interest-only payments, the borrower is not building equity in the house. if the borrower is not building equity, the concept is similar to renting, particularly if home values are stagnant or decline. The amount you owe on the mortgage will never decrease. Even worse, some interest-only payments don’t cover the full amount of interest due each month. The excess, non-paid interest would then be tacked onto the principal, causing the borrower to owe more in principal than the home was worth when purchased.
When house values are declining, like they have been in many areas of the United States, this problem is compounded. Not only does the borrower owe the full purchased value of the house while making the interest-only payments, but the house’s declining values means the borrower will quickly owe more than the home is worth. Then, if it is sold, the borrower could owe more money to the lender than he received in the sale.
Interest-only payment options don’t last forever. After the interest-only period ends, the lender will expect the borrower to start paying back the principal. This can result in a significant increase in the number written on the checks sent to the lender. If the income hasn’t increased as expected or if the business has not moved past the “growth” stage, the new payment — a larger payment than you would have had throughout the life of the mortgage if the interest-only option was not selected — might be unaffordable.
The Federal Reserve Board has a helpful comparison chart outlining the differences in payments you might expect if you choose an interest-only payment option, reproduced below. Notice how low the equity is in the last column, identifying borrowers who opt for the interest-only method.
Do you have or have you had an interest-only payment option on a mortgage? Please share your experiences or opinions.
(Or… What on Earth is an Affidavit of Financial Hardship?)
Today the U.S. Treasury announced the details of their “Making Home Affordable” Loan Modifications. This link to the financialstability.gov Web page about the plan should help you answer whether you are eligible to receive help with your “underwater” mortgage.
Here’s a good summary from a PDF linked from the above Web site that helps explain who the program is for:
The Home Affordable Refinance program will be available to 4 to 5 million homeowners who have a solid payment history on an existing mortgage owned by Fannie Mae or Freddie Mac. Normally, these borrowers would be unable to refinance because their homes have lost value, pushing their current loan-
to-value ratios above 80%. Under the Home Affordable Refinance program, many of them will now be eligible to refinance their loan to take advantage of today’s lower mortgage rates or to refinance an adjustable-rate mortgage into a more stable mortgage, such as a 30-year fixed rate loan.
The one thing I found while reading about this that I wasn’t familiar with is a requirement to sign an Affidavit of Financial Hardship. Googling for it resulted in a number of State-specific PDF forms, but I did find a generic Affidavit created by Fannie Mae so you can at least have an idea of what to expect.
Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation) are companies that buy mortgages from lenders. Those lenders, by selling loans to the companies, have more cash on hand to lend to other individuals. Fannie Mae and Freddie Mac then “repackage” the mortgages and sell them as securities to other investors. These are guaranteed investments. Investors will receive the returns promised regardless of the quality of the underlying mortgages.
Those promises have been in danger lately, as news traveled that without intervention, Fannie Mae and Freddie Mac might fail. The companies were having trouble making their obligations to investors.
Backed by the government or not?
While Fannie Mae and Freddie Mac are government sponsored enterprises, the government until recently did not back the companies and guarantee that investors would be paid in the event the companies failed. That was changed recently when the Federal Housing Finance Agency, a government organization, took the two organizations under conservatorship. Shareholders in the two companies will find that their shares will be devalued even beyond the recent declines in order to help the companies pay their obligations. The U.S. Treasury now has the ability to provide funds directly to these companies to ensure their stability.
Interestingly, Herb Allison will be the new CEO of Fannie Mae. Astute Consumerism Commentary readers recognize this name as the former CEO of TIAA-Cref. Many reports from current and former TIAA-Cref employees tend to agree that Mr. Allison did not do such a great job of cleaning up the mess left by his predecessor at that company.
The possible effects of the takeover
Dean Baker, an economist with the Center for Economic and Policy Research, a think tank in Washington, D.C., says, “I think that the immediate impact will be somewhat positive. You’ll see some drop in mortgage rates because it’ll decrease the uncertainty” that had pushed mortgage rates up this summer.
Baker says he can imagine a drop in mortgage rates of around a quarter of a percentage point, give or take about 5 basis points. A basis point is one-hundredth of a percentage point. “It’s something,” he says. “It’s not going to make a huge difference.”
Why aren’t people buying homes right now? It’s not because interest rates are too high and it’s not because the majority can’t qualify for loans (though I’m sure many people in fact cannot). House prices are still too high. Well, a buyer perceives prices to be too high for what he or she believes to be the real value of the house, but perception is reality. If they believe the price to be too high, they won’t buy, regardless of the mortgage interest rate.
I’m not an economist, but I think in general prices need to fall farther before the housing market picks up and people start believing there is a “buyer’s market.” I don’t think a drop in rates of a quarter of a percentage point will make that big of a difference.
If this takeover amounts to not much of a difference in the lives of Americans, is it really worthwhile for the government to seize these semi-private, semi-public corporations? Remember that now that they are backed by the government, taxpayers are footing the bill for rescuing investors in Fannie Mae and Freddie Mac (that is, the lenders). Perhaps, if you consider that the alternative — letting the companies fail — might have a more devastating effect on the economy.
Photo: respres
How the Fannie and Freddie takeover affects you, Bankrate.com via MSN MoneyCentral
I really enjoy good “data visualization”, which is a fancy, but more succinct way of saying “a way to look at information as more than just numbers.”
Last year, before most of us were aware of the “mortgage crisis,” some enterprising individual took a list of average housing prices in the United States since 1890, adjusted them for inflation, and then plotted them as if they were altitudes on a roller coaster ride. Watch the video, and you won’t be so surprised why the housing market took a downturn:
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