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My wife and I bought our first home at the end of 2016 and finally closed after a long, painful, drawn out process (no, I don’t want to talk about it) in early February 2017.
I am the first to admit that I can drag out a decision for quite a while. I am an intense thinker. My wife is shaking her head right now as she reads this. I debate the pros and cons and think about all of the variables until I finally get around to making the decision that I think is best.
This is how our home search went. We looked at $200k homes (don’t do it Ryan!), we looked at $300k homes (are you an idiot Ryan?!) and eventually I just couldn’t stand the thought of possibly being house rich and cash poor and we decided to go with the $135k home (good choice Ryan).
It was like the angel and the devil on my shoulder trying to convince me which was the right decision for our family. Ultimately, the main reason we thought we needed the $300k home was simply as some sort of prize or badge of honor. You know, we have a big house so we must be rich! Wrong!
Thankfully the angel got through and told me that there are more important things than a big house. Eventually your children are going to grow up and move away and all those bedrooms will be empty.
One of the biggest decisions that we had to make was the type of mortgage we were going to utilize. With interest rates as low as they are there was no debating whether or not to get a fixed rate. About the only way rates can go from here is up. Now we just needed to decide the length of the mortgage.
We looked at 15, 20 and 30 year mortgages and compared the rates and payments. Essentially, the shorter term you choose the higher your monthly payment but the lower your interest rate. For us, the decision came down to the 15 or the 30 year.
The investor in me likes the flexibility of a 30 year mortgage. Not only does that equate to less fixed costs every month but I could also invest the difference and certainly get a return that is more than the rate we were quoted.
The saver/debt hater in me liked the 15 year mortgage because I would be paying less interest and more principal every month therefore getting out of debt quicker. Besides, I had just become debt free in the past couple of years and wasn’t too keen on the idea of taking out a mortgage at all!
So I did the math to see what the difference would be.
Regardless of which route you go, here is the key. Buy a home that is BELOW your means. Practically every one of my friends or acquaintances has a nice big home with lots of bedrooms, lots of bathrooms, the newly remodeled kitchen, blah, blah, blah. and a HUGE mortgage. I am making an assumption there, but you get the point. Who are you trying to impress? And why?
The chart below breaks down the exact decision that we had to make. We were putting 20% down (highly recommend this) so that we didn’t have to pay private mortgage insurance (PMI). Which would you choose?
|Mortgage Length||15 years||30 years||Difference|
|Total Interest Paid||$30,973||$77,618||$46,645|
|Interest in first 5 years||$16,401||$20,620||$4,219|
That is a $46,645 difference. That is all interest. All money that goes to the bank. You essentially get nothing for this money. It is gone.
Imagine what that money could turn into in 20 years with an 8% return. The answer…. over $217,000.
And for all you number crunchers out there I know that you would not receive the $46k up front to be able to invest it immediately. This is simply to illustrate the enormous difference in interest savings.
Your forever home?
The reason I calculated the interest difference through the first 5 years is because I wanted to see how much savings there would be if we decided to move or upgrade our house in 5 years or so.
Most people don’t stay much more than 7 years at any house on average. That is a $4,218.17 difference in interest paid in the first 5 years. Not a huge amount but that’s $4k down the drain. Something to chew on anyways. If we were certain we would be moving to a different house within 5 years I probably would have gone with the 30-year mortgage since the savings isn’t as significant and we would have more flexibility.
Related: The aftermath of becoming debt free
Principal is principal. The nice thing about the 30-year is that your payments are lower allowing you to do other things with your money. I think that is fine as long as you are investing the bulk of this difference and not just blowing it as discretionary income every month.
I considered going this route so that we could save up more for a down payment on a rental property.
In the end I just couldn’t stomach the idea of paying so much interest. The biggest advantage of the 15-year is the higher payments which pays down your principal quicker and allows you to build equity faster. Yes, you can just make extra principal payments on the 30-year but if you are planning to do that you might as well get a 15-year mortgage that comes with a cheaper interest rate.
In a perfect world this is the best option.
You pay $0 interest and you own your home outright from the get-go. It sounds good in theory but there are some downsides to paying cash for your house.
Right now and for the last several years interest rates have been ridiculously low. Investors have been able to leverage this cheap interest and buy more investment properties. If all of your money is tied up in your house, that is equity that you can’t get to unless you go and take out a Home Equity Line Of Credit (HELOC) or sell your home, which is obviously very time-consuming and expensive.
This is where the word “opportunity cost” comes in to play. I knew that eccentric economics teacher in college was teaching me some useful things! Opportunity cost is essentially what you are missing out on.
If you could borrow $50k of equity from your house and make a 10% return on it, the opportunity cost is the difference between that return on your investment and what you would have to pay to borrow that money. So if you could borrow that money at 3.5% and make 10% then your opportunity cost is 6.5%. I’m not necessarily advocating for one or the other just simply laying the facts out in front of you so that you can make an educated decision. Obviously that 10% return is not guaranteed, but the 3.5% you are paying to the bank is a guaranteed fixed cost.
What’s best for us
I think we made the wise decision by going with the 15-year mortgage. Now the question is how quickly can we pay off the mortgage…
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