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Everything is fast in our society. We have instant messaging, one-hour dry cleaning and fast food. How about a fast mortgage? Well, even though a 15-year mortgage might not seem fast, it's twice as fast as the standard 30-year loan. And the savings are amazing, as is the speed with which you build equity in your home.
To start, the interest rate is lower on a 15-year mortgage since the lender's money is tied up for a shorter period. The difference is usually half a percentage point, but it can vary. If you have to pay private mortgage insurance Private MI) you can save even more. People putting less than 20 percent down on a conventional loan have to pay mortgage insurance to protect the lender in case they default. While the interest you pay on your mortgage is tax deductible, private MI payments are not. You have to keep paying that premium until you have 20 percent equity in your house—the difference between the value of your home and what you owe on it. By paying off the loan twice as fast, you will hit that 20 percent equity mark more quickly.
Let's look at how a15-year mortgage works by comparing it to the more common 30-year loan. We'll look at $100,000 and $150,000 mortgages and figure out how much equity you would have on the $100,000 mortgage after five years--since that's when many people move or refinance--and how long it takes to build 20 percent equity in the home.
A $100,000, 30-year mortgage at 6 percent will require a basic monthly payment of $599.55. That is just principal and interest, and does not include insurance, taxes, or association dues, fees, or assessments. If you were to keep that home and that loan for the full 30 years, you would end up paying $215,838.53. That splits into $100,000 to repay the loan and $115,838.53 in interest. After the first five years you would have made 60 payments totaling $35,973, and you would still owe $93,054.39 of the $100,000 you borrowed, giving you about $7,000 in paid equity. As far as private MI is concerned, you would not cross the magic 20 percent line until the 140th payment, which would be your eighth payment in your 12th year. By that time you would have made $91,131.60 in monthly payments and would still owe $79,886.05 in principal.
Now let's look at that same loan taken out as a 15-year mortgage with 5.5 percent interest--the typical half-percentage point less you would get compared to a 30-year mortgage. Your basic monthly payment would jump from $599.55 to $817.08, an increase of $217.53 a month, or 36 percent. Again, this does not include insurance, taxes, and so forth. At the end of 15 years you would have made 180 monthly payments totaling $147,075.36. Of that only $47, 074.36 would be interest, compared to the $115,838.53 you would pay in interest on the same loan at 6 percent spread over 30 years. That's a savings of $68,764.17, or roughly 60 percent. So, by paying 36 percent more every month, you save nearly 60 percent on your interest payments. After five years, you would have made 60 payments totaling $49,024.48. You would still owe $75,289.23, but you would have nearly $25,000 in paid equity. In other words, you would have paid off roughly one quarter of the total loan. And you would have crossed the magic 20 percent limit for private MI payments with your 50th payment--the second payment in your fifth year.
If you run the numbers on the same 30-year and 15-year mortgages but increase the loan amount to $150,000 on each, the results are about the same. Although you are making bigger payments on a larger loan, with the 30-year mortgage you wouldn't cross the 20-percent private MI threshold until you reduced the loan by $30,000 (20 percent of $150,000). But that would happen at the same time as with the $100,000 loan--the eighth payment in the 12th year. With the 15-year loan your payments would again be 36 percent larger than they were with the $100,000. Were you to keep the loan for the full 15 years, your interest payments would be roughly 60 percent of what you would have paid for a 30-year loan. And you would cross the 20 percent line at the 20th payment again, the second payment in the fifth year.
What does it all mean? Well, in general terms, choosing a 15-year mortgage over a 30-year will mean that your basic monthly payment will be bigger; usually 30-some percent bigger, depending upon your interest rate. So even though you'll pay the loan twice as fast, you will not be making twice the monthly payments. You will also be paying roughly 40-some percent less total interest than you would with a 30-year loan. The exact percentage depends upon your interest rate.
Is it worth the extra money every month? It depends on whether you can afford the larger amount and on your long-term goals. If you look at your home as an investment, and most of us do, the faster you pay down the principal, the more equity you have. You can turn that equity into cash at any time through a Home Equity Line of Credit (HELOC) or a second mortgage. If you'll be moving in a few years, the money you pump into your home translates into more cash when you sell it. If you're looking forward to retirement and don't plan to move, you might like the idea of a mortgage-free house to complement the reduced income that comes with retirement. The main thing to remember is that 15-year mortgages are an option. The decision comes down to whether this option is something that works for you. |
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