What makes the standard 30 year mortgage the norm for purchasing a home? The answer is if we didn't have the 30 year mortgage most people would not be able to afford the home they are in. The 30 year mortgage allows them to qualify and have an affordable payment. Affordable being a relative term.
How it normally goes is that you find your dream house, you need to apply for a mortgage of $200,000. The rates are at 5%. You look into the payment on a 15 year mortgage and it is $1581 a month. You could probably swing it, but your hesitant. Your mortgage broker says you can get a 30 year mortgage and the payment would be only $1073. Yes, a $500 savings. You could really use that $500 for a lot of other things. It's temping and you decide on the 30 year. Bam. You just made the biggest mistake of your life.
By taking the 30 year mortgage, over the 30 years, you will of paid $100,000 more to the bank in interest. For that $200,000 house you will have given the bank $386,511. If you had a 15 year mortgage, you will only have to give the bank $284,685 over a 15 year period. What could you do with that $100,000 if you could of kept it in your pocket. What things were you not able to do because you gave all that money away? I have an alternative.
The 30 Year Home and Retirement Plan.
Start with the same $200,000 house purchase. Apply for the 15 year mortgage. Make the payments and pay off your house in 15 years. It's doable. Fifteen years will fly by and you will have a paid off house. Now your living in a paid off house, right? Take the same house payment and invest it every month. Put it in a stock and bond mutual fund or ETF's. Do this monthly investment for 15 years. Your writing checks as if you were paying on a 30 year mortgage. But now you are paying yourself.
If your investments grow at a rate of only 8%, which is a conservative percentage, at the end of 15 years your investment balance will be $547,089. Next step quit your job and retire. Your house is paid off and you have more than a half million dollars in the bank. If you wish to continue working 5 more years, continue with the plan and continue to make the monthly investment. At the end of the 20th year your balance will be $931,246. Almost one million dollars, now please retire.
"The 30 Year Home and Retirement Plan" will take planning and discipline on your part. It's a long term plan that will take good budgeting and sharp planning. The heart of the plan is the 15 year mortgage. The hardest part will be your determination to have a 15 year mortgage. It's so tempting to get a 30 year mortgage. I can hear the reasons for having a 30 year. I have heard all the excuses. With a 30 you have a lower payment and more cash flow to do other things in life. You may claim you will pay of the 30 off in 15 years. You just want the leeway in case some trouble comes down the road. The best thing about a 15 year mortgage is that it always pays off in 15 years.
The ground rules for this plan to work is you need to purchase a home that is affordable to you. It must not be so pricey that the payment makes you house poor. What is an affordable payment? The rule of thumb is only purchase a home where the payment is 25% of your income. If you earn $4000 a month, then largest house payment you can afford is $1000.
It's your choice. Make payments for 30 years to the bank or make payments for your home and to your future.
Dave,
ReplyDeleteWell said! I especially frown on 30 year mortgages if retirement could happen within that 30 years...retired people don't need mortgage payments!
This being said, my 33 year old son took out a 30 year mortgage on his house, which allowed his wife to become a stay at home mom. Everything you said is true financially, but they really couldn't find much of a home that he could pay off in 15 years. Ideal? No! But the value of having a stay at home parent is not too bad of a trade off.
By the way, they are working on this home and improving it greatly, so they may be in position to sell and buy something else which they could pay off quicker.
Joe, I like how your son has made all the right decisions. The 15 year mortgage is a great idea but life happens and it sometimes can't be done. I put my plan out there to make people think that the normal way of buying a home is not the only way. When I bought my first house I never gave any thought to a 15 year mortgage or retirement. I wish knew then what I know now.
ReplyDeleteWe got a 30 year mortgage on our last house and paid it off in seven. The longer mortgage gave us the opportunity to never be in a pinch. Of course - since that mortgage was bundled and sold- It is still on our credit as an unresolved mortgage!
ReplyDeleteInteresting post Dave! I don't disagree, but I took a different approach. I could swing a 15 year mortgage, but I chose to do a 30 year one but pay it off in 15 years. Sure I might be paying slightly more, but the money is liquid if for some reason I need the extra payment.
ReplyDeleteJanette, way to go on paying off the mortgage early. That was a lot of sacrifice on your part. I wish I could do that but I just don't have the cash flow.
ReplyDeleteMoneycone, you did it the way most people do who pay it off early. That flexibility lets you sleep a little better at night.