Mortgage flexibility is not cheap

At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here’s an explanation for

Dear Dr. Don,
I’m a first-time homebuyer purchasing a home for $289,900. I have a family income of $78,000 per year, with $120,000 in available funds. Which is a better loan to take when making a $110,000 down payment and borrowing $180,000 — a 20-year loan at 4.75 percent or a 30-year loan at 4.99 percent that I will pay off over 20 years?

With all the talk about inflation and the value of money, which loan would be more beneficial? We usually take the standard deduction in taxes because I work for someone else. Never having owned a home, I have some fears about unplanned expenses that can come up. I have two young children. I am interested in tapping your expertise and experience in helping me make this decision.
— John Jump-start

Dear John,
I’m a big proponent of financial flexibility — that is, making sure there’s enough flexibility in your investments and monthly spending that you don’t find yourself in a difficult financial situation because you’re overextended.

Keeping just $10,000 of your $120,000 in savings as cash reserves raises a red flag. I’d like you to have an emergency fund equal to three to six months’ worth of living expenses. As a first-time homebuyer, you’ll learn that you need to budget some money for decorating your new home, too.

Taking out the 30-year mortgage with plans to make additional principal payments to pay off the loan in 20 years gives you a measure of financial flexibility. If there’s a period of time when you can’t afford to make the additional principal payment, you’re not contractually obligated to make that additional payment.

You’re paying a price for that flexibility, however — namely the 0.24 percent difference between the interest rate on the 30-year and 20-year mortgages. If you’re not fully able to take advantage of the mortgage interest deduction, the effective rate on your mortgage is closer to the stated rate on the loan.

All else being equal, the financial goal should be to minimize the total interest expense on the loan. Ignoring any tax effect, the 20-year mortgage saves you nearly $10,000 more in interest expense versus the 30-year mortgage with additional principal payments made that are equal to the difference of the two mortgage payments, or $198.02.

Savings by mortgage plan
30-year mortgage 30-year w/additional

principal payments

20-year mortgage
Loan amount: $180,000 $180,000 $180,000
Interest rate: 4.99 percent 4.99 percent 4.75 percent
Loan term (months): 360 249 240
Additional principal payment: $ — $198.02 $ —
Regular monthly payment: $965.18 $965.18 $1,163.20
Total monthly payment: $965.18 $1,163.20 $1,163.20
Total interest expense: $167,464.49 $109,104.02 $99,168.61
Savings (compared to 30-year): $58,360.47 $68,295.88

Flexibility is the chief advantage of choosing the 30-year mortgage, plus extra principal payments. You can capture about $58,000 of interest savings while only leaving $10,000 on the table in order to keep $200 worth of flexibility in your monthly budget.

You’ll need to decide which approach makes more sense to you. As a first-time homeowner with two young children, I’d think you’d value the flexibility. Chart out how high your payments would be at different rates by using’s mortgage calculator.

To ask a question of Dr. Don, go to the “Ask the Experts” page, and select one of these topics: “Financing a home,” “Saving & Investing” or “Money.” Read more Dr. Don columns for additional personal finance advice.