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It seems that 30-year mortgages are very common (standard?). If I find that the monthly payments for, say, a 10-year mortgage are affordable for me, is there any reason not to go with the shorter term so that I can reduce the amount of interest paid and get out of debt faster?

Or maybe it's just a sign that I should be looking at more expensive properties?

43

Answers to this your question break down along a few lines regarding opportunity costs of tying up a significant chunk of your salary and assets in one piece of property, as opposed to other things you'd like to do with your life.

History

The 30 year standard mortgage was invented in the 30's as part of FDR's new deal to make housing affordable to more people, while relieving the strain on the market of foreclosed homes from ~10 year interest only balloon mortgages (sound familiar?). The 30 year term tends to follow the career of the average American of that era, allowing them to pay the house off and live out the remainder of their lives there at a lower cost.

The real Value of a Home

Houses are depreciating assets because they wear out over time. Their greatest investment value is a place to live. The appreciation on a home comes from the real estate it sits on and the community the property is located in. Value is determined by desirability of the house and community in their current state, and the supply of property in the area. This value can only be extracted when you sell the home. This partially answers your last question noting that you shouldn't buy a really expensive building for investment value. We've learned in recent years that there are no long term guarantees of property value either, because land and communities can decrease in value due to unemployment, over supply, crime, pollution, etc. Only buy as much home as you will need in the next decade or so, in a place that you will like living over that time period, and don't consider it much of an investment.

Paying it off

I will tell you to get a fifteen year fixed rate mortgage since it's readily available at lower rates and has a significantly lower total purchase price than the standard 30 years. The monthly payment difference isn't that great, and anyone who looks at the monthly payment as opposed to the total costs, your priorities and the opportunity costs shouldn't be trusted for financial advice. I don't like debt. There are psychological benefits to being free from the bondage and drain of a long term mortgage on your finances.

The biggest argument for paying off your home quickly is freedom to pursue other desires with all of your salary and the assets you have available to you.

Some financial advisers will tell you to keep your mortgage costs under 25% of your income, so that you can actually live off the money you make. I would also recommend paying at least enough into your 401k to get the company match and fully funding your Roth IRA. I'd also have an emergency fund to cover at least 6 months of expenses, including this mortgage in case you lose your job. A 15 or 20 year mortgage will give you breathing room to take care of these other priorities, and you can overpay on almost any mortgage to decrease the principal and finish in a shorter time period (make sure to get a mortgage that allows prepayment) .

Diversifying into other investments

More financially savvy people may tell you to take the 30 year mortgage and invest the difference. Especially with mortgage rates around 4%, this is a very cheap way to increase your purchasing power and total assets. Most people lack the investment prowess and self discipline to make this plan pay off. There are even fewer guarantees regarding markets and investments than property.

This also is a way of diversifying your total assets to protect against loss of value in your home. This approach has backfired for thousands of people who are underwater on their homes. This problem is often compounded by job loss forcing you to move, or increasing your commute, making your home less desirable for you.

Some people will tell you to maintain the mortgage for the tax credit. This fails a basic math test since you only get about a quarter of the money (depending on your tax rate) that you are paying in interest back from the government. The rest of the money goes to bank at no gain to you. This approach is basically a taxpayer subsidized decrease of your 4% interest payment to a 3% interest payment (assuming you have ~ $5000 in other deductions), and only pays off if you can successfully invest the money at a rate somewhat greater than 3%.

  • My own reasoning was that (a) I wanted it paid off at about the same time I retire, (b) I had significantly more than the value of the house in savings, so I could pay off the mortgage at any time if I wanted to, (c) I didn't want to make a complete bet on the market but (c) historical market-rate-of-return was sufficently above what the loan would cost me that I was willing to make the morgtage into a "leveraged investment". So I compromised: I financed half the cost of my house. (And later refinanced to even lower rates.) But I'd already proven myself as a long-term investor. – keshlam Dec 2 '14 at 2:36
  • I mostly agree with this, but it doesn't take much prowess or self-discipline to take the difference each month and dump it into an index fund. – Hart CO Apr 9 '17 at 16:55
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Assuming you've got no significant prepayment penalty, I would think about getting a longer mortgage, but making payments like it was a shorter mortgage. This will get the mortgage paid off in a shorter time period - but if you run into financial difficulties and/or find a better use for your money, you can drop back to paying the minimum necessary to retire the loan in 30 years without needing to refinance. (If you need to reduce your payments because you're between jobs, you don't have a very good negotiating position).

For the most part, there's nothing that says you can only make one payment per month, or that it must be in the amount printed on the statement. If you want to, you can make payments weekly (or biweekly, or every 4 weeks) which typically means that you'll pay more every year.

If your mortgage payments are $1000/month, that's $12,000 per year. If you tell yourself that 1000/month = $250 weekly and make yourself send a payment every week (or 500 every 2 weeks), you'll end up paying 250 * 52 = $13,000 per year, without particularly feeling the difference, especially if you get paid on a weekly/biweekly schedule instead of monthly or semi-monthly. Also, by paying more often, you're borrowing a tiny bit less money over the course of the year (because the money didn't sit in your account waiting until the 1st of the month to make a payment) so you save a little in interest there, too.

Think of "30 years" or "10 years" as the basis for a minimum payment schedule, not necessarily the length of time that you or the lender really intend to keep the loan.

  • 2
    Thanks, that's a very interesting idea. Is this something that I should be asking the bank about beforehand, or would that raise alarm bells for them? – Larry Wang Sep 5 '10 at 18:08
  • This allows you to keep your options open while taking advantage of today's low rates. – James Roth Sep 5 '10 at 20:31
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    Be politely aggressive to assure that you get a mortgage with no prepayment penalties and that your payments can be electronically transferred and credited against your mortgage balance immediately (some banks will hold funds in escrow and charge a months worth of interest before applying it against your balance). This shows the mortgage servicer that you are financially savvy, especially if you are willing to walk away if they won't accommodate you. You don't want to do business with someone who is trying to screw you on fees and unearned interest. – SpecKK Sep 6 '10 at 0:40
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    If it raises alarm bells, you need to find another lender/broker. – duffbeer703 Sep 6 '10 at 1:13
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    You may be able to get a lower interest rate for a 15-year mortgage, though. – fennec Sep 7 '10 at 16:28
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If you can afford the payments on a 10-year mortgage for a property, that's an indication that it's very affordable. This assumes that there aren't a ton of hidden costs in this property (which could be why it's going so cheaply).

Looking at more expensive houses just because you can afford them is exactly what the lenders want you to do, and it's dangerous. Resist the temptation. If you're happy, you're happy.

5

The monthly payment difference isn't that great

On a $300K loan, the 30 year monthly payment (at 4%) is $1432, the 15 year (at 3.5%) is $2145, that $712 per month, or 50% higher payment. $712 is the total utility or food bill for a couple. If that $1432 represents 25% of income (a reasonable number) then $2145 is over 35%. I'd rather use that money for something else and not obligate myself at the start of the mortgage.

Given how little we save as a country, the $712 is best put into a matched 401(k) in the US or other retirement account if elsewhere.

4

With interest rates as low as they are, you could lock in to a very low rate for 30 years. If rates are higher in, say, 10 years, you could conceivably be earning a much higher rate on the money you're not putting towards monthly payments.

All else equal, the payments will be lower on a 30y than they will be on a 10y, so you'll have more cash for other things.

But I'm just looking for downsides -- being paid off in 10 years versus 30 sounds nice to me.

3

With the calculator in hand (Excel :) you should follow this advise and save a bundle.

1) Calculate how much you are willing to spend per month.
2) Take the longest (in years) mortgage you can find and cheepest (Euribor+0,2% is better than Euribor+1%).
3) Save the amount you are not spending on your mortgage.

Whenever the mortgage cost changes (once a year), calculate whether you get more interests on your savings or on a down payment (look at the total cost). Then decide if you make a down payment or keep on saving.

My 0,02€

We took a 20 year mortgage and blindly payed every time we'd have 3K€. We payed our house in 6 years. The total cost of the mortgage was way down this way. However, the above theory has a better yield overall.

  • I'd go for the longer mortgage (just in case you hadn't noticed) – GUI Junkie Sep 4 '10 at 21:17
  • I'd vote @SpecKK up for 'Diversifying into other investments' but I can't. Ow, well. – GUI Junkie Sep 4 '10 at 22:57
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It depends on your situation. Situations may change.

There are also other factors:

  • The ability to deduct mortgage interest, combined with other charitable contributions is essentially a subsidy of your mortgage. If you donate $5k to your church, you probably don't clear the standard deduction, but with the mortgage deduction, you could yield a $1,500 annual return from that contribution.
  • Taxes are likely to increase, so the value of that deduction will increase as well.
  • Rates are very low, and get pushed lower by your deductions. You're basically getting free money.

Being free and clear is nice, but there is an opportunity cost.

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