Finances are not my strong point so looking for some advise. Buying a new house and the loan will be for $90,000. We will likely be able to pay that off in 7 years. Question is should we go for the 15 yr at 2.7% or the 30 yr at 3.1%? My senses say do the 15 but I may be missing something.
Thanks in advance.
Playing with the a mortgage calculator at Bankrate, this is what I get.
Overpaying the 15 year mortgage to finish it 7 years will require $550 extra per month, $1159 total monthly, for a total 7 year payout of $99,033.
Overpaying the 30 year mortgage to finish it in 7 years will require $800 extra per month, $1184 total monthly, for a total 7 year payout of $100,322.
By that metric the 15 year is best. However, that is completely ignoring opportunity costs associated with overpaying. Is there something better you could be doing with that $550 or $800 than paying it into your mortgage; a return of only 2.7% or 3.1%?
(Those are just estimates, the exact dollar amounts might be off.)
There’s a lot that goes into this decision. What are your retirement savings like? How stable is your job? What’s your risk appetite? My general gut feeling is that you should take the 30 year, maximize your retirement savings, and then pay down the mortgage if you have anything left. The small rate advantage of a 15 year loan isn’t that big of a deal compared to the pain you might be in if you have to take a home equity loan later because you run into financial difficulty. You also can earn more money in general in retirement investments than you would paying down a mortgage at either rate. Certainly it’s a guaranteed return, but unless you’re already basically at retirement, any money you can put into a retirement account will grow much better than the interest you’re saving, so maximize that before paying down a mortgage.
Hard to answer this in a GQ sense.
It will depend on how financially stable you expect to be and what your investment strategy would be for the money if not spent on your mortgage.
If debt reduction is your highest priority, the 15 year option and paying it down in less than 15 years is a good option.
But if you think you can do about the same or better than a 2.7% return, it may be better overall financially to plan on paying it off in 15 years and investing the extra money. You can also deduct mortgage interest from your taxes, so that complicates the calculation.
And if you think you can invest and do better than 3.1%, the lower monthly payments combined with the mortgage interest deduction might be the best overall.
YMMV in a big way.
Well sure, going with the lower rate is a no-brainer if you know you’re going to pay it off in 7 years. The main problem is what if you suddenly can’t and are stuck with nearly twice the payment? That’s in addition to the question of whether you can get a better return on the money through investments. It’s a matter of weighing risks, both with your job and with the stock market.
It’s very unlikely if you’re married and have a $90,000 loan that you’re going to be getting much use of the mortgage interest deduction. If you’re single that’s another story, but getting up over the standard deduction for joint filers with less than $3,000 in mortgage interest is not possible unless you are very generous with charitable contributions or have a ton of medical bills.
The biggest issue isn’t the rate difference, or whether you can invest the difference at a better return. The biggest issue is whether you are so confident in your income stability to commit to the higher minimum payment of the 15 year.
I had a mortgage broker hit me with the same line, as he was trying to push me into a 30 year loan over a 15 “just make the higher payment you would for the 15 into the 30, and you’ll pay it off in just 17 years!” (or whatever the time). My response was that the extra few thousand that would cost me was not worth the ability to drop to a lower payment (my financials are pretty secure), and that if I do need a lower payment, I could always refinance, which wouldn’t cost any more than extra cost of the 30 year.
Another big thing for the OP to consider, is there any other debt? If you have car, credit card, or student loans at more than 3.1%, then get the 30, and use the extra money to pay off the other debt before paying down the mortgage. Paying down debt is a guaranteed return, but only as large as the interest rate.
It’s also not necessary to do an all or nothing. Diversification is important in investing. Put money in different investments. It is perfectly reasonable to put some of your extra income into paying down the mortgage, and others of it into savings, rather than paying down as much as you can afford.
This assumes you’re able to get the same rate. Your financials may be secure today, but the fact that you even need a loan says that you don’t have the extra cash to pay for it just lying around, and a lot can happen in a few years’ time. Rates can’t go down much right now, but I think it’s reasonable to think that in 5 years they’ll be at least a few percent higher.
Great information. Thank you all. A lot to think about for sure. We are basically debt free and have pretty stable incomes but anything could happen so maybe the lower payment is the safest.
Thanks SDMB.
It absolutely is the safest, though it definitely will cost you money for that safety margin. Think of taking the higher rate and lower payment as an insurance policy. If you think whatever kinds of insurance you get now are worth the money, paying a little more on the mortgage overall in order to be sure you don’t lose your house might be worth the money too.
It comes down to can you depend on making the payments on the 15 yr loan. If that puts you in a potential bind the 30 year may give you more flexibility to have a lower monthly payment if needed. If you can reasonably account for the payments of the 15 year loan then yes that’s the one to get. However consider the option of other investment opportunities of that money.
There are many situations in which that’s not true (in general. Obviously I don’t know your circumstances). The most likely case where one might want to lower a housing payment, for example, would be in a long period of unemployment. Good luck getting that refi without a job.
When faced with the same decision as the op, we went for a 30-year. We could easily cover the payments on the 15 year unless something bad happens. But lots of something bads are correlated with having a lot less financial flexibility in other ways.
Since this involves advice and opinions, let’s move it to IMHO (from GQ).
Factual information regarding loan structures, payment rates, etc. is of course still welcome.
I’m in the camp of “why would you want to pay a loan at 2.7% off early?”
I’ll assume that the OP plans on being able to pay off the loan in seven years is due to extra principal payments over the course of seven years, rather than expecting a rich relative to die about that time (in my experience, planning that is harder than it looks and brings about it’s own set of risks. I don’t advise it). But seriously, I think you are overthinking this, as you have a loan amount that you can easily afford, and at a time of low rates. If you don’t want to play the arbitrage game by investing the extra cash, simple sock it away in a savings account month after month. Maybe get 0.25% to 1% if you are lucky, but it will give you the advantage of liquidity if you do happen to need the cash. When the balance is up to where you can pay off the loan balance with it you can decide then between having no payments or a decent pile of cash.
Personal anecdote alert: we recently remortgaged at 1.41% fixed for 5 years (the longest fixed period widely available in the UK, where I am - the expectation is that after that, you will remortgage again, if not you are stuck with the same lender and will revert to a higher rate, currently around 3.5% to 4% variable). Ideally I would have liked to fix for 10 years or even longer, on the basis (as someone has already said) that rates can’t possibly get any lower than they are now, and I’d like the security. But we couldn’t find a lender willing to lend the amount we wanted (we wanted some extra for home improvements) for that period. Then again, the last 2 times I have remortgaged (5 years ago, and 3 years before that) I have thought the same thing (that rates couldn’t possibly get lower) and been proved wrong.
Our situation is that we are very financially stable - at the moment - and like the OP, hope to pay off the mortgage balance significantly sooner than the full notional term (which in our case is 32 years). But having security is nice. I’m happy to take big risks with the investments in my retirement fund (I’m 35), but less so with money for paying off the mortgage. For that reason, on my previous mortgage (which was at 2.79%) I decided to overpay rather than invest the difference. I think that’s quite conservative, but I don’t regret that decision. In the current market, you have to take a significant amount of risk to generate returns better than 2.79%, and while with hindsight I could have done so, I was happier to have the security of paying off the mortgage earlier.
However, at 1.41% I have now taken the plunge and rather than overpaying on the mortgage balance, I am investing the difference and hoping to use the total sum invested to repay some of the mortgage principal in 5 years’ time. As others have pointed out, this also gives more flexibility in case that money is needed for something else in the meantime.
If the figures in post #2 are accurate, if I were the OP I think I would consider the extra $25 per month for 7 years a reasonable price to pay for ‘insuring’ against the possibility of needing to change plans (e.g. a significant, unexpected drop in income, which might leave me unable to refinance). Which also contains the assumption that I wouldn’t want to invest to try and beat 3.1% in the current market. YMMV.
At todays low interest rates, I really can’t see a reason to avoid debt. As long as inflation is positive and the interest rate is at or close to inflation, what negative is there in a longer loan? You will benefit by paying it off with cheaper dollars. Why give that up?
And please realize that you are making a very simple, binary decision here. In a world full of nuances and details. Don’t be distracted by one number being slightly higher than another. That is noise and you can’t make a principled decision looking at noise. Keep your inputs robust enough to equate to a simple yes or no decision.
The one key bit of info you’ve left out is your family income level.
For many people, $90K is not a lot of money, and the payments on that loan, whether over 30 years or 15 years, are not a big deal. A lot of people in this thread are advising you to keep financial flexibility, but if you have enough income that the payments on a 15 year $90K mortgage still leave you with flexibility, then you may be overdoing it.
If, on the other hand, your income is such that the payments on the 15 year loan are all you can make if everything stays at is, then you may benefit from lower payments and some more slack in the 30 year term.
It sounds like you’re a two-income family? If so, take the shortest mortgage you can pay with one income. The greatest risk to failing to pay a mortgage is job loss. Loss of one job is something you need to prepare for. Loss of both jobs simultaneously is very unlikely, unless both are with the same business.
With one income paying the mortgage, that leaves you the other income to be flexible with. Save, invest, or pay your mortgage early. You can change your choices easily. I recommend keeping in savings or checking enough to cover your basic living expenses (mortgage, utilities, food, etc) for six months as an added cushion.
Google “two income trap” and how to avoid it for more info.
A basic rule I teach my math students is lowering risk costs money. When we study investments we look at blue chips stocks with lower dividends vs “dividend traps” and low yield government bonds vs high yield junk-bonds.
In loan payouts a safer (lower) payment has a higher interest rate like in your case.