Terms: 15-year vs. 30-year vs. 20-year
Most borrowers focus on interest rate to save money on their mortgage, this is overly simplistic and not very cost effective. Allow me to illustrate my point with some real world numbers. Even at today's historically low rates the numbers are a real eye-opener. Below are three different mortgage scenarios for an amortized fixed-rate loan (repayment of principal and interest) for $400,000 at 4.375%.
* Total Payments: $718,971
* Total Interest: $318,971
* Total Payments: $600,884
* Total Interest: $200,884
* Total Payments: $546,206
* Total Interest: $146,206
Remember, the interest rates and loan amounts for all three are the same. Which one would you rather pay? Even among No-brainer's, the obvious choice is scenario 3.
What's the difference? THE TERM: Scenario 1 is a 30 year, scenario 2 is a 20 year and scenario 3 is a 15 year. In short, the savings between a 15 year mortgage and a 30 year for a $400,000 loan is $172,765.
But wait (as they say on TV infomercials), there's more. It gets even better because the rates for shorter term loans are even cheaper.
You can get a 20 yr. fixed rate today at 4.25%, thus the total payments would be
* Total Payments: $594,464
* Total Interest: $194,464
And you can get a 15-yr. fixed rate for 3.5%, so the payments would be*
* Total Payments: $514,715
* Total Interest: $114,715
Thus, the actual savings between a 15 yr. term and a 30 yr. term would be $204,256 ($318,971-$114,715).
DID YOU KNOW THAT ON A STANDARD 30-YEAR FIXED RATE MORTGAGE...
* Not until year five does 30% of your payment goes toward principal.
* Not until year fifteen does 50% of your mortgage payment goes toward principal.
AS CONTRASTED WITH A STANDARD 15-YEAR FIXED RATE MORTGAGE...
* During the first year, 60% of your payment is going toward principal reduction.
* By Year seven, 75% of your mortgage payment is going toward principal reduction.
THEREFORE, IF YOU CAN AFFORD A 15-YEAR PAYMENT, THIS IS THE WAY TO GO!
Even so this is only half the story because of the opportunity cost. What could you do with those potential mortgage payments if you retired your mortgage debt 15 years earlier?
Borrowers can realize considerable savings by restructuring their loan term. If a person doesn't have the cash flow to handle the payments on a 15 year loan, I advocate 20-year loans, which offer two thirds the benefit term-wise, with only one third the payment increase.
30-yr. Term Monthly Payment: $ 1997
20-yr. Term Monthly Payment: $ 2477
15-yr. Term Monthly Payment: $ 2859
On the other hand, even with the relatively low payments that a 30 year terms affords borrowers, there are still folks that need something with even lower payments and a longer terms like 40-years. Based on what we have covered you pretty much know the pros and cons of these loans.
The Pros: Where affordability is an issue because of income (or in more costly markets) they offer lower monthly payments.
The Cons: They build equity at a snail's pace and consumers who keep these loans end up paying far more in interest than they would with a traditional 30-year fixed-rate mortgage.
To keep our comparison of apples to apples the same, I*ll use the same $400,000 loan amount for an amortized fixed-rate loan with a 40 yr. term.
* Total Payments: $909,978
* Total Interest: $509,978
* Monthly Payment: $1895
Today*s prevailing rate on a 40 yr. term would be at 4.875%. As you can see when compared to a 30 yr. term your payments would drop about $100 per month, but the Total Interest paid over 40 years nearly total $190,000 more. Thus, term is far more impactful than rate when it comes to financing one*s home.
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