Times are tough for the American homebuyer.
Home prices are the on rise, right along with mortgage rates, and there simply aren’t that many houses on the market. The improving economy means people are starting to feel wealthier, but with wages stagnant, they’re taking on more debt to buy a home.
With inventory so low, prospective buyers must be prepared to make a quick decision on a property, which means you must have a firm understanding of what you think you can afford to borrow.
A central question you need to ask is: Am I better off with a 15-year fixed-rate mortgage, or a traditional 30-year one? Here are some pros and cons of 15-year fixed mortgages to help you make the decision.
1. You save a lot on interest
A homebuyer today has a decision to make.
You can sit on the sidelines long enough to build sufficient savings to afford a higher monthly payment with a 15-year mortgage or jump more quickly into the rising market by taking out a 30-year loan and enjoying a lower mortgage payment but more borrowing costs overall.
And you can save a lot of money with a shorter loan.
Let’s say you put down 10 percent on $264,800 home – the average price for existing home sales, according to the National Association of Realtors – and borrow the rest from a mortgage lender with a 4.55 percent interest rate.
You’ll end up paying more than $175,000 over the course of the mortgage, or about $84,000 more than you would with a 15-year loan.
To achieve those savings, though, you’d have to pony up an extra $700 per month.
Use Bankrate’s mortgage calculator to estimate your monthly payments and see how much house you can afford.
2. Forced to save
Many Americans struggle to save.
Some households may not have the means to put money away, while others, especially those who support children or older parents, may be suffocated by costs.
Or you might simply lack the discipline to save. Enter the 15-year mortgage.
You have only so much income, and if more is directed toward your house, then you’ll participate in less frivolous spending.
Forcing yourself to save in a liquid financial asset, like a savings account, would give you more flexibility should you find yourself in need of cash.
3. A less costly retirement
Nearly 4 in 5 households led by someone over the age of 65 own their home, and half have no debt on it whatsoever, according to the Bureau of Labor Statistics. That’s a big reason retirees spend about $6,000 less than those between the ages of 45 and 54 on housing.
A mortgage-free retirement erases a major ongoing payment while you’re living on a fixed income and allows you to use your home as a source of income, through a reverse mortgage, should you need the cash.
Those in their 50s with solid savings and job security, and the desire to be mortgage-free by 65, should consider a 15-year mortgage when moving or refinancing.
1. Your savings may suffer
Americans, by and large, are not good at saving. Here’s a sampling:
- On savings: Just 39 percent of Americans could pay for a $1,000 expense in cash, according to a Bankrate survey.
- On college savings: 4 in 10 parents aren’t saving for college, according to Sallie Mae’s annual report, while the average family has less than $20,000 saved.
- On retirement: Just 60 percent of families helmed by someone between the ages of 55 and 64 own a retirement account, and those that do have just $120,000, according to the Federal Reserve. If you were to put that amount in an immediate annuity, you’d receive a monthly check of around $600.
By tying yourself to a large monthly payment to save money in the long run, you can put yourself in a bind along the way.
Payments for a 15-year mortgage “are nearly 50 percent higher than that of a 30-year loan, which can strain the household budget and leave little in the way of wiggle room,” says Greg McBride, CFA, Bankrate chief financial analyst.
2. House-rich, cash-poor
Of course, you’re getting something for your money: more of your own house. But tying cash in a single asset carries significant risk.
“The faster pace at which equity is built is of little consolation in the event of financial difficulty as the additional home equity is inaccessible,” McBride says. “Money in the bank, or other liquid financial assets, will pay the bills – home equity will not.”
3. Fewer tax perks
The new GOP tax bill will result in fewer tax filers itemizing their deductions, thanks in large part to a higher standard deduction. (The mortgage interest deduction was made less generous, too.)
The Tax Policy Center estimates that just 1 in 10 households will now itemize, down from 30 percent last year.
This is especially true for those with a 15-year mortgage, by definition. Less interest paid means less interest to deduct.
Still, chances are you are going to take the standard deduction anyway.
When is a 15-year mortgage right for you?
This might feel counterintuitive. Who wants to give more to the bank?
But a mortgage isn’t like credit card debt. Interest rates, despite rising recently, are historically low, meaning your borrowing pain is dramatically reduced. Why not take advantage of this low fixed-rate loan, especially if you can deduct your mortgage interest payments, and use the leftover cash to secure your finances?
Fully fund your six months’ worth of emergency savings, ramp up your savings in your child’s college account and contribute 15 percent of your pay into a tax-preferred retirement account. Pay down any bad debt, like a hefty credit card balance.
A house is more than an asset to most people – it’s your home. It’s where your family grows up, your memories are created, and stories are shaped. You will likely feel a deeper connection to it than, say, your bank account.
Which makes sense.
But that doesn’t mean you should own it quicker than you can afford.