Things are heating up in the housing market as we start to see more millennials move out of their parent’s house and into their own home. Many of these buyers want to take advantage of the current low mortgage rates… because these rates are definitely going up, right?!
It seems that everyone has been threatening rising rates for years, but rates have remained low. People wanting to take advantage of low rates over the past couple of years have already re-financed to take advantage of the even lower rates.
This time, though, it’s different when people threaten the rising rates. Rates are almost certainly bound to go up, and given the scorching temperatures of the housing market that we are currently seeing, now is a good time to get into a new house.
If you’re looking to buy a new house, you have to ask yourself, “What is best for us and our budget? Should we go with that 15-year mortgage that shows an extremely low rate around the 3%, or should we carry our home mortgage for 30-years and go with a slightly higher rate and spread this out?”
The answer comes down to whether you want financial flexibility or to make the technically correct financial decision. Surprisingly, Wela’s answer happens to lean against that “technically” correct answer.
Flexibility Versus Cost
Flexibility is king when it comes to this decision. The benefit of having a 30-year mortgage is that, despite our rate being higher, our actual mortgage payment tends to be considerably lower. The reason for this is that we are spreading out the mortgage payment over many more years… 15 more to be exact! The con to this is that we are now forcing ourselves to pay our mortgage for a longer period of time.
It’s a financial principal to try and eliminate your debt. However, another financial principal is to make sure we are able to financially handle all of the curveballs that life throws us. Whether that is a pay cut, a lost job, or an emergency expense that arises, most people will find in their lifetime that they need financial flexibility.
Taking on a 15-year mortgage is the “technically” financially sound decision if we were just looking at the numbers and nothing else. Get the debt paid off quicker and reduce the amount of interest we have to pay those big wig banks is typically the best financial decision. However, let’s look at a more specific scenario. Say we have a $200,000 mortgage and assume the rates are close to what the national average is currently. Over the life of the 15-year mortgage, you would pay about $52,000 in interest. And over the life of the 30-year mortgage you are paying about $151,000 in interest.
That’s $100,000 difference in interest cost alone! So yeah, in this regard the 15-year mortgage makes a whole lot of sense. There are, however, two other important factors to take into account. By going with the 15-year mortgage, you are locking yourself into having to pay nearly $1400 per month for the mortgage. Whereas with the 30-year mortgage you are only obligated to pay $975 per month. The keyword here being “obligated.”
If your financial situation changes to the negative, you are still obligated to pay $1400 per month with that 15-year mortgage. With the 30-year mortgage, you can always pay more. If your financial situation is great right now, you can go ahead and pay more on that loan… but if things change you have the ability to reduce that spending and use that extra money on living and getting through that difficult financial situation without having to necessarily move out of your house.
As things continue to get better within the economy it’s easy to fall into that “invincible” mentality. We aren’t necessarily as wound up or worried about our job security as we were just a couple of years ago. These folks might be saying, things won’t change… until they do and they’re stuck with that greater mortgage amount.
Don't Waste Your Savings
The 30-year mortgage offers a 30% lower monthly payment than the 15-year mortgage. That means you could actually save that extra 30%, and it could go towards your retirement savings. Or perhaps you are in high growth mode within your family and kids are starting to cost you a bit more. Well, now you have 30% more savings, relative to the 15-year, which you can put towards your kids’ education or possibly their extracurricular activities. Let’s be real, it might even just be food to keep those growing teenagers fed!
Again, it just allows us to be flexible and not bound to a higher payment. Because maybe today things are good, but we don’t know what tomorrow will bring. Financially speaking, it is always great to have flexibility and to limit the ‘contractual’ obligations that we have within that expense category. Ultimately, we never know when we may have to buckle up with our financial situation.
Now it’s hard to ignore that huge chunk of change you’ll be paying in interest to a bank in a 30-year mortgage versus a 15-year mortgage. To make sure that you’re not simply throwing that money away, you have to actually invest that money you’re actually saving.
We get it. Who wants to take that additional $400 or so every month and save it in their investment account? That's tough to do for even the most disciplined. However, there is a trick to force yourself to do this. Instead of looking at that money in your bank account each month, just increase your contributions to your 401k based on the difference in savings you have with the lower mortgage payment.
So, with our example of a $200,000 mortgage and current mortgage rates, we are saving about $5,000 every year in mortgage payments. So, the day you close on your new house, go to your 401k provider’s website and boost your contribution by whatever percentage necessary to start saving an extra $5,000 a year to the 401k. This way it is automatic, and you won’t even notice it.
This leads to multiple benefits. One is tax savings because the money comes out of your paycheck before taxes and thus lowers the amount of your salary that you are forced to pay taxes on. Secondly, it could boost the amount of free money that you can get from your company. If your company currently matches your 401k, this can boost the amount that is being contributed to your 401k every year by the company. Lastly, it allows you to partake in the power of compounding to an even greater degree than perhaps you’re currently utilizing.
Again, the benefit of doing this as well is that you have flexibility in what you contribute to your 401k. So, if you find yourself in one of those emergencies that calls for financial flexibility, then you can reduce the amount you are contributing to the 401k and utilize the extra cash flow to help you cover that spending need that you currently have.
Now that we have an answer to what mortgage makes more sense… the next major decision we need to make when it comes to buying a home is how much home can we afford and should we buy?
We suggest you try the home buying tool we have within the YourWela.com portal. It's based on your financial picture, and you can quickly turn it into a goal to help you track your saving. Just sign up for a free account to try it out today!